Behind The Mysteries Of The Federal Reserve by [email protected]

Wharton’s Peter Conti-Brown discusses his new book on the Federal Reserve.

In The Power and Independence of the Federal Reserve, Peter Conti-Brown, a professor of legal studies and business ethics at Wharton, attempts to demystify the Fed and its role in the U.S. economy.

Conti-Brown recently appeared on the [email protected] on Wharton Business Radio on SiriusXM channel 111 to talk about the book.

[drizzle]An edited transcript of the conversation follows.

[email protected]: The Federal Reserve (Fed) has been right there in the front of a lot of what you see in the news these days: anything revolving around the U.S. economy, and in some respects, the global economy as well…. Talk a little bit about [the concept behind the book].

Peter Conti-Brown: Any time you talk about the Federal Reserve, especially in the public — especially after the crisis, frankly — there’s this sense of mystery, the sense of conspiracy. If you look in the Library of Congress catalog of books on the Federal Reserve, there are shelves that have just grown under the weight of the conspiracy theories behind them. Some of these are pretty harmless — for example, the Council on Foreign Relations and the Federal Reserve run the global political system through Bohemian Grove, or something like that. [Some] are kind of silly. Some of them are actually quite evil. It won’t surprise you, a lot of anti-Semitism shows up in these books.

Part of what was motivating me over the last six years that I’ve been working on this book was getting at what makes the Fed such a uniquely mysterious institution, that draws these conspiracists out. On one part it might be, “Oh, because what the Fed does is so technical.” Many of us stopped taking math in high school. Those of us who continued math through college still didn’t get the education needed in order to do monetary policy in the heavily mathematical way that it’s done.

But that actually doesn’t make much sense as an explanation either. Because if you’ve ever read an application to the Food and Drug Administration for a new medication, you’ll see it is not written in English. This is only for experts. The same is true for the EPA [U.S. Environmental Protection Agency], or the FCC [Federal Communications Commission], or any other agency of government. This is technical work. So that doesn’t distinguish the Federal Reserve. That’s the same with all of them.

What does distinguish the Fed, and here’s part of the title of the book, is this extraordinary concept of independence. So we have the story about national government coming to us from the Constitutional Convention, and the pen of James Madison, that government is this tripartite structure. We’ve got legislative, executive and judicial. Well, where does banking come in?

Formally, legally, the Federal Reserve is a creature of Congress. It’s created by statute. But its functions are quite different from functions of making law or enforcing law or judging between competing views of law. It is a financial, a banking function. The Federal Reserve is structured by time and practice and law, to be apart from these other three branches. It’s not a co-equal branch of government. As I said, it’s subject to Congressional and other kinds of political oversight. But there’s this idea that the Fed is independent.

When I started working on this book about six years ago, it started as an article. I started puzzling through, “Well, what do we mean by this concept of independence?” In some sense, independence sounds great. That’s like motherhood or fatherhood or apple pie.

[email protected]: All-American, right?

Conti-Brown: It’s All-American. We are independent. But what does it mean when you say you’ve got an independent central bank? Well, scholars have been studying central banks for centuries. They have been studying this concept of central bank independence most actively for about the last 30 to 40 years. They have a working definition of independence, which I learned very early in my research. It goes something like this.

Let’s refer to the Federal Reserve in particular. So, the Fed is independent because number one, there is a legal separation between the Fed Chair — Janet Yellen, Ben Bernanke, Alan Greenspan, and the like — and the President. The reason for that legal separation between those two people is because we want the Fed Chair, who runs the Fed, to make monetary policy with an eye toward price stability, low inflation.

“Any time you talk about the Federal Reserve, especially in the public — especially after the crisis, frankly — there’s this sense of mystery, the sense of conspiracy.”

If we put that set of tools in the hands of the President, the President wants to either run for re-election or insure a good legacy. The fear is that the President will have the temptation to goose the economy artificially with high inflation so that short-term problems go away, even if they create long-term problems down the road.

There are about five aspects of that definition I just described. Number one, the law is doing the work here. Number two, that the Fed is just a single person, the famous face that we see in the newspapers. Number three, that the outside audience that’s trying to influence monetary policy and the Fed policy is the President. Number four, that the Central Bank’s mission is very technical and technocratic. It’s only the work of expertise. There are no values, ideologies. In a word, no politics. Then the fifth one is that the Fed is only oriented toward keeping inflation low.

In my book, I … pop each one of those as myths. The Federal Reserve is a “they,” not an “it” or a “she” or a “he.” Its internal governance matters enormously, in terms of who exercises power within the Fed. More than just the President are interested in how the Fed operates on the outside. This includes other politicians, like members of Congress. But it also includes international central bankers, academic economists, the public, the markets in the abstract and many others.

Number three, law is not doing the work people think it’s doing. I trained as both a historian and as a lawyer. As I’m reading through these statutes and thinking about how they changed over time, I saw that the stories we tell about the legal structure of the Fed are largely sometimes incomplete, sometimes false.

Number four, this idea that what constitutes central banking is just the purview of experts, and if you take the right classes and take the right exams and you write the right papers, everyone will agree. That’s incorrect. For the most interesting and most controversial of decisions that central banks have to make, there’s a point at which the technical apparatus is exhausted and doesn’t produce a unanimous decision.

Then there’s a gap between that point where being an expert’s not going to help you anymore and the moment of decision-making. What fills in that gap? Well, this is a word central bankers don’t like to hear, but it’s true. Ideology. Values. Judgment. Now, that’s not peculiar to central bankers. We all have ideologies. We all have values. But the point is that the values of the individual central bankers are

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