Federal Reserve Independence

Financial Services Practice Group and Regulatory Transparency Project Teleforum

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In years, the issue of Federal Reserve independcy have arison to the top of public discussion. Questions have arrisen surounding the Federal Reserve that have plagued policy and lawmakers for decades. Should the Federal Reserve be “independent”?  Is that a political, or a technical question?   Has the Federal Reserve been independent historically?  Has a US President ever fired a Fed Chairman?  Who should determine the definition of money?  How much faith should we have in the judgments of the Fed?  This Teleforum will delve into these and other issues of central bank independence. 


Alex Pollock, Distinguished Senior Fellow, R Street Institute

Norbert Michel, Senior Research Fellow, Financial Regulations and Monetary Policy, The Heritage Foundation

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Event Transcript

Operator:  Welcome to The Federalist Society's Practice Group Podcast. The following podcast, hosted by The Federalist Society's Financial Services and E-Commerce Practice Group, was recorded on Thursday, February 28, 2019, during a live teleforum conference call held exclusively for Federalist Society members.     


Wesley Hodges:  Welcome to The Federalist Society’s teleforum conference call. This afternoon’s topic is Federal Reserve Independence. My name is Wesley Hodges, and I am the Associate Director of Practice Groups at The Federalist Society.


As always, please note that all expressions of opinion are those of the experts on today’s call.


Today, we are very fortunate to have with us Mr. Alex Pollock, who is a Distinguished Senior Fellow at the R Street Institute. Also with us is Mr. Nobert Michel, who is a Senior Research Fellow for Financial Regulations and Monetary Policy at The Heritage Foundation.


After our speakers give their remarks, they will have a back and forth, and then, eventually, we’ll move to an audience Q&A. So please keep in mind what questions you have for the Fed, for some of their remarks, or for one of the speakers individually, and be ready to present your question at that time. Thank you very much for sharing with us. Alex, I believe the floor is yours to begin.


Alex Pollock:  Thank you very much and many thanks to the Federalist Society for hosting this discussion of what is, obviously, a very important issue. Of course, in recent times, over the last few decades, we have all heard about Federal Reserve independence, and the idea has been endlessly repeated, that the Fed must be independent. But this is not an obvious conclusion. And historically, the opposite opinion has often been prominent and often been the reality. I’m going to take the questions listed in the invitation in order, in case you want to follow along.


So one, should the Federal Reserve be independent? No. No part of the government in our constitutional republic should be outside the system of checks and balances or outside of serious accountability. A phrase from Allen Sproul, who was a longtime president of the Federal Reserve Bank in New York in the 1940s and ‘50s, is appropriate here. He said, “The Fed is independent within the government” -- independent within the government. That’s masterfully ambiguous, but it’s clearly not the same as independent. It’s related to the idea that you can be both independent and accountable, if you can figure that out.


William McChesney Martin, who is the hero of Fed independence to many people and who is considered, because of that, by President Truman to be a traitor, was chairman of the Federal Reserve from 1951 to 1970. Martin interpreted independence within the government like this. Here’s what he testified to the Congress. He was careful to frame his arguments in terms of independence from the Executive Branch, not from Congress. “It’s clear to me,” he said, “that it was intended the Federal Reserve should be independent and not responsible directly to the Executive Branch of the government but should be accountable to Congress. I like to think of a trustee relationship, to see the Treasury does not engage in the natural temptation to depreciate the currency.” Well, the Treasury is the biggest borrower there is, so, of course, the Treasury has the natural temptations of borrowers.


Question two, is Fed independence a political or a technical question? Well, it’s a political question. Money is always political, and Federal Reserve actions always have political effects. Like over the last decade, taking money away from savers so you can give it to speculators, those are political actions.


Three, has the Federal Reserve been independent historically? Well, often not. In the beginning, the Federal Reserve Act in 1913, the original version, made the Secretary of the Treasury automatically the Chairman of the Federal Reserve Board. So that’s a pretty clear indication of what they were thinking about in the beginning.


The Federal Reserve Board in those days met in the Treasury building, and it did until 1935. And as reported in one history of the Federal Reserve, the Federal Reserve Board members felt degraded and humiliated by the Treasury Department’s treatment. The Fed was made an adjunct of the Treasury Department, rather than an independent body. That’s talking about the nineteen-teens in the early days. During World War I and, again, during World War II, the Fed was the servant of the Treasury, financing or buying the bonds needed to finance the war. In World War II, they explicitly bought as many bonds for the Fed portfolio, as many bonds as was needed to keep the interest rate down to 2.5 percent.


Then, along came the Korean War. President Truman and his Secretary of the Treasury, John Snyder, wanted to continue this arrangement, that the Fed made sure it was financing the government for the war. But the Fed wanted out. This was the famous debate that led to the Federal Reserve Accord. But this debate in 1951 was under especially difficult circumstances because, by then, we were losing the war in Korea and retreating down the peninsula. Truman is confronting that, trying to finance the war, and here was this Federal Reserve trying to raise the cost of borrowing by the government. I have a lot of sympathy for Truman there. This led to a very public dispute between Truman -- between the Truman administration, including the President himself, personally, and the Fed, which brings us to the next question.


Has a U.S. President ever fired a Federal Reserve chairman? That got quite a bit of play recently. And the answer is yes. Truman effectively fired Federal Reserve Chairman Thomas McCabe as part of this, at the time, famous public dispute. Truman told McCabe that, quote,
"His services were no longer satisfactory." And McCabe resigned, and that’s about as close in substance to being fired as you can get.


In the next decade, the 1960s, President Johnson did not try to fire William McChesney Martin, but we find this interesting occurrence. In late 1965, the Fed raised short-term rates, alarmed by signs of inflation after tax cuts and the war in Vietnam’s ramping up. President Johnson summoned the Fed chairman to his ranch in Texas. There, Johnson physically shoved Martin around the living room, saying Martin didn’t care about the boys in Vietnam, according to historian Sebastian Mallaby. That’s quite a scene to imagine.


Next question, who should determine the definition of money? The Constitution clearly assigns this responsibility to Congress. And in the Federal Reserve Reform Act of 1977, Congress told the Fed, as one of its key mandates, that it was to seek stable prices – "stable prices". The Fed, on its own, changed this mandate to a commitment to perpetual inflation instead, at the rate of two percent. In one of the open market committee’s debates of this idea, one of the members suggested the Fed ought to ask Congress what they thought about that. But this suggestion was not taken up by the committee.


Lastly, question six, how much faith should we put in the judgements of the Fed? Well, very little. Since these judgements are, obviously, really guesses, they should inspire as much faith as any other bunch of guesses about the economic and financial future. And, as we know, the Fed’s forecasting record is as bad as everyone else’s is.


In summary, you should believe in a completely independent Fed only if you believe that there should be platonic philosopher kings who preside over economics and finance, but who in the world would believe that? Thank you.


Norbert Michel:  Thanks, Alex. Unfortunately, anyone listening in for debate on this topic with different sides is going to be disappointed because Alex and I are very much on the same page with this issue. There’s an excellent book out, and I’m not getting anything for saying it’s a good book, but Sarah Binder and Mark Spindel have a book out in the last couple years called The Myth of Independence. The title is pretty much something that I’ve used in the past, but I think a lot of people view this independence as this thing that the Fed has. And it’s true that, in fact, it is a big myth.


If you go through the history, just sort of like Alex did and then even deeper, the Fed’s never been independent politically. It’s never been completely independent of Treasury. It’s never been completely independent of Congress. And the Binder and Spindel book have a lot of the Congressional part in there, so it’s good for that. But if you go back through, just even on the administrative side, there is an even more expansive list than what Alex has gone through. President Eisenhower pressured Chairman Martin to increase the money supply, and Martin didn’t want to. Eisenhower pressured him, and it was sort of a resign or reconsider your position. And Martin reconsidered.


The, I think, maybe a little bit more known, well-known within our circles anyway, is the President Nixon and Arthur Burns spats. Well, not really spats, but their collusion on one of the famous Nixon tapes. Nixon and Burns openly mock and laugh at the idea that the Fed was independent. And Jimmy Carter found William Miller as uncooperative, so he replaced him. He moved him over to Treasury, so maybe that wasn’t really looked at as a firing. But he moved him out of the Fed. And then if you go into the Volcker years, and I think that’s probably where -- this is just my supposition, but I think that the sort of modern view of this independence is probably a lot because the Volcker Fed has this great reputation of killing inflation and so on.


But if you go and you look at this closely, this was not an independent Fed. This was a Fed working very closely with the administration, the Fed acknowledging that the needed the support of the administration to do what they were doing, which, in fact, makes sense. So that’s not independent at all, under any normal definition of the word independent.


And then, just to fast forward to the 2008 crisis, this is one that I think needs to be discussed more frequently. Look at everything that happened between Ben Bernanke as Fed chair and Tim Geithner as Treasury Secretary, or New York Fed President and Treasury Secretary Paulson. I don’t know how you could possibly call the Fed independent throughout any of that time.


And much of that was not strict, pure monetary policy. Much of that was emergency lending, but most of it was done in strict compliance between the two, Treasury and the Fed. And this is, as you know, a time period where the balance sheet blew up like crazy, and you don’t have that without some agreement on policy between the administration and the Fed. The point that I’ll make to finish that one off is that this actually works out great for Congress because they have two people to beat up on now. They have the administration and the Fed, and they can posture and they can gripe at the Fed on what the Fed’s done. And they can gripe at what the administration has done, even though the ultimate responsibility does lie with Congress.


So it’s a way for them to shed accountability -- Congress to shed accountability, and, as we’ve seen throughout history as well when we try to talk about making the Fed more accountable, whether it’s through Congress or whether it’s through some other rule that would sort of separate them, Congress balks at that. And it’s always a political fight. And I think you’d have a really good case to make that Congress wants to have that buffer. They want to be able to bring the Fed chair up and yell at him or her for whatever they want to yell at them for. And anything that has gone wrong in any way, they can do that if the Fed is supposed to be independent. Right? So they want that.


And if we’re talking about things like federal debt, federal deficits, unemployment, these things are always going to be political. So I don’t know how you'd really get away from that, but I think, if you go back to even Milton Freedman -- Milton Freedman was on record as saying, look, this is a fiction. We should make them part of Treasury. If you don’t want to make them part of Treasury, make them more directly accountable to Congress. So in terms of what should happen, I’d be happy with either one of those two. And I think I’d even lean more towards the side of Treasury because it is very much as Milton said.


It is very much a fiction and sort of an accident -- maybe not an accident. Maybe it’s political -- it is political that they’re not on budget. What the Fed’s doing is not on budget, even though they’re holding an enormous amount of U.S. debt. That’s probably where I’ll cut my time off there. I think I’m pretty close to my seven or eight minute opening.


Alex Pollock:  Norbert, let me just say I agree with what you say, and it’s certainly true that complaining and taking accountability are two different things. And thank you for filling in the history so well because, of course, this is, as you say, the steady pattern over time. I have two quotes here that might be good. The second one is Burns, since you mentioned Arthur Burns, but the first one is said to be a story that Marriner Eccles, who is also one of the great long-serving Fed chairmen is said to have loved this story.


He asked a central banker from another country, “Do you feel your bank has the right to defy the government?” “Oh, yes,” the central banker replied, “We value that right very greatly, and we would never exercise it.” That’s one, and the second one is a famous Arthur Burns line, which is about Fed independence, “We can’t exercise our independence for fear of losing it.”


Norbert Michel:  I love that one. Yeah.


Alex Pollock:  So it is clear in here there is a political matrix because, as I said, money is inherently political. And the whole big political part of the history of the United States was devoted largely to debating the politics of money. And part of the outcome of that was the original Federal Reserve Act, as we know. But in the -- when you’re in some kind of a crisis, then somebody has to take responsibility. And then you get this group, as you were saying, like the Treasury, and the Fed, the leaders in Congress, who do things under pressure. So this brings me to a thought which is the Fed should be independent, except in times of war, crisis, or economic challenges.


Norbert Michel:  Except every day.


Alex Pollock:  There you go.


Norbert Michel:  Well, I do. I think that the politics part -- the politics of this has a lot to do with why we don’t see some sort of stricter monetary policy rule and why we don’t get rid of the silly mandate that we have with Congress. Because it might sound paradoxical, but a good way for the Fed to not have to deal with political pressure would be to restrict them to following policy rules. But Congress doesn’t want to do that.


Alex Pollock:  Well, then the writer of the rule is responsible.


Norbert Michel:  That’s right, and they don’t want to do that. And Congress doesn’t want that. Congress wants to be able to browbeat them, and that’s what’s going to keep happening, I think. I just don’t see -- even though we would have better monetary policy, you just don’t see that coming.


Alex Pollock:  I mentioned the natural desire of the Treasury, as the biggest borrower for low interest rates, cheap financing costs, and having the Fed buy its bonds, which, of course, today, the Fed owns huge amounts, as we know, of Treasury bonds, a couple trillion dollars’ worth. And those are all long. This was one of the really radical parts of the quantitative using program that they -- at least, in current terms, it’s radical. It was going back to the World War II pattern where they bought the long bond to keep the rates down. But in between, we had a Fed which believed in the bills only doctrine, which is they should by all Treasury bills.


The argument being that was the least economically, or financially distortive vehicle you could use. The amount of Treasury bills, I was just looking at the Fed’s current balance sheet yesterday and noticing the amount of Treasury bills. The amount of short-term securities they own is zero.


Norbert Michel:  Zero. Yup.


Alex Pollock:  And they own all these long bonds. And of course, they also own a ton of mortgages, which was much more radical. But in principle, we could say, in principle, a central bank can buy anything. And central banks have done -- the Swiss National Bank right now is doing -- owns lots of equities, and they’re big buyers in the U.S. stock market, for example. And a central bank can buy mortgages. It could buy equities. Obviously, many buy gold.


The Fed owns zero gold. Many central banks own gold. And if you think about what complete independence would mean coupled with the notion that you could be using your balance sheet to manipulate any financial sector, that’s a pretty daunting thing to imagine.


Norbert Michel:  Yes, and a democracy, one would argue, would not want such a situation.


Alex Pollock:  Yeah. Well, I wouldn’t want it.


Norbert Michel:  No, no, absolutely not. You have a completely isolated group in that they’re not elected and they’re not going to face voters, essentially allowed to run a large bank for the government.


Alex Pollock:  Speaking of that, we ought to mention something you and I have discussed and actually testified together on, which is the notion that the Federal Reserve, or central banks in general, should be allowed to have deposit accounts with the public or anybody. Which is, just like in principle, they could buy any asset. In principle, they could make commercial loans. In principle, they could finance your charge card, just like they are, today, financing your mortgage.


In principle, once you have, technically, the possibility of running large numbers of accounts, any number of accounts of any size, you could imagine the Fed having accounts directly from you and me and businesses and universities and local governments and anybody and becoming the monopoly bank of the country. Because who wouldn’t choose to put your money in the Fed instead of someplace else, as you and I’ve discussed? But that’s actually if you had a completely independent Fed which decided that it wanted to do that. That would also be a daunting possibility. And it’s technically possible.


Norbert Michel:  It is technically possible, and it is even seriously discussed now in many policy circles. And it’s a horrible idea, I think. It completely usurps any sort of private banking sector in the long run because you’re not going to have, obviously, private banks willing to compete with the federal government running a bank. I mean, that’s just -- it’s a terrible idea. It inflates monetary and fiscal policy even more, but it is actually something that is seriously talked about amongst some academics now. We here proposals for things like central bank digital currency.


It’s really important to pay attention to the fine details, the fine print of those proposals, because some of those are exactly what Alex is talking about here, which is it is sort of like you have a debit card with the Fed. A Fe-bit card, I think, is a term we could use. And it is literally having the Fed compete with commercial banks, which is so far beyond anything even envisioned by the founders of the Fed. And it’s completely unnecessary and harmful in the long run. I think, among some of our friends, that might be obvious. But again, it is actually not obvious, again, to many other people. And it is being seriously considered by some.


Alex Pollock:  Yeah. That’s a good point. One of my favorite saying is, “Many things which were previously considered impossible, nevertheless, came to pass.” And things that the founders of the Fed would have considered impossible, nevertheless, have come to pass, like the Fed being the biggest owner of mortgages in the country.


Norbert Michel:  Indeed.


Alex Pollock:  So things which start off as mere ideas can come to pass in time, if you don’t pay attention to them.


Norbert Michel:  No doubt. Look, maybe this is getting a little bit too far into the weeds, but with a completely independent Fed, another thing that we could see—this is a very real possibility—is the Fed shooting for permanent inflation at an even higher level than what we’ve already got.


Alex Pollock:  Oh, yes.


Norbert Michel:  That’s again -- John Williams, when he was in San Francisco, started talking about that, and that’s a very real possibility. And there’s really nothing to prevent the Fed from saying, “Well, price stability now is constant, low, steady inflation. And we think it’s four percent.” And it might have seemed incredibly far-fetched in the ‘90s and early 2000s, but it’s not so far-fetched right now.


Alex Pollock:  It’s a great irony, isn’t it, that the two percent inflation target, which was invented in New Zealand in the 1990s and then adopted by most everybody else, had, as it’s whole point, getting inflation down to two percent. It was an excuse for reducing inflation for everybody at that time. And it has become transformed into a reason for increasing inflation. There’s some historical irony for us.


Norbert Michel:  That’s a great point. It really is.


Alex Pollock:  Well, Wes, maybe we’ve worn ourselves out.


Wesley Hodges:  Very good. Something tells me you have some more gas in the tank, but let’s go ahead and open the floor to questions, everyone. Let’s go ahead and go to our first caller.


Will McCauley (sp):  Hello, this is Will McCauley in Washington, D.C. I appreciate you two putting this on today. I did want to ask how does the Fed, today, in terms of its independence level -- how does it compare to the Bank of the United States that was around back in the 1800s? Is it a wholly different animal or can you kind of compare the independence level the two institutions have or did have?


Norbert Michel:  Very, very different animals. I know that some people will sort of gloss over this. And actually, I’m not sure. Maybe Alex will disagree with me, but I’ve heard many people gloss over this and say, “Well, we sort of had a central bank with the Bank of the United States.” But we had nothing like a central bank with the Bank of the United States. There was no macroeconomic policy. We were still on the gold standard. You did not have credit allocation for the nation in the same way. Very, very, very different animals.


Alex Pollock:  First of all, let me say I think that is a really great question to think about. And of course, there were two Banks of the United States --


Norbert Michel:  That’s right.


Alex Pollock:  -- Hamilton’s Bank of the United States, followed by the second bank. And they were both commercial banks. They were partially government owned. The boards had government representatives and also private capital on them because Hamilton’s principle was you couldn’t -- the bank wouldn’t behave responsibly if there wasn’t large private capital at risk. And of course, the Fed, legally, has shareholders who are private shareholders, namely the commercial banks. But they don’t have any ownership rights in those shares to speak of.


So they’re different cases, but it’s intriguing, actually, to speculate on. I think the better analogy for the Banks of the United States is not the Fed, but the government-sponsored enterprises, like Fanny Mae and Freddie Mac. The Banks of the United States were, in my mind, a lot like Fanny Mae. And if you read Andrew Jackson’s veto message when he vetoed the re-chartering of the second Bank of the United States, it reads, in its key parts, like a wonderful indictment of Fannie Mae. That’s something I enjoy a lot.


Norbert Michel:  That’s a great analogy. That’s a very good point. It’s much more appropriate, I think, to look at them that way.


Wesley Hodges:  Well, very good. Thank you so much, caller, for your question. While we wait for any more questions from the audience, Alex, Norbert, I have just two words I want to present and see where your thoughts are after that: interest rates.


Norbert Michel:  I know everybody wants to talk about interest rates, and I think that, obviously, interest rates are important. But I think that we’ve fallen into a trap where we sort of -- we have the sort of popular notion that the Fed just makes interest rates whatever they want. And I think you can kind of even see some of that coming out of the White House. “Well, the Fed just made interest rates too high,” or “We want them to make interest rates lower.” Depending on what the market equilibrium rates are, the Fed can try all they want to raise or lower rates, and they’re going to have the opposite effect. It’s not the case that they simply make interest rates whatever they want. That’s been one of my pet peeves.


Of course, they have influence over them, and of course, they’re important. But whether rates are going up or down, it depends on conditions in the market, as well as what the Fed’s doing. It’s not the case that they simply just program in and get whatever rate they want. It’s actually quite dangerous to think of it that way, I believe.


Alex Pollock:  I have a few thoughts. Of course, there’s the financial markets treat Federal Reserve opinions and moves on interest rates as market moving events. And that’s what makes the most important is the fact that the market moves around based upon them because everybody thinks it will move around. It’s one of those paradoxical nature -- paradoxical things about financial markets. But interest rates, we need to make at least two distinctions. One is long rates and short rates in a "bills only" Federal Reserve world. Focusing on the federal funds rate, the direct object of the Fed’s targets were short-term rates.


If you get into a quantitative easy world, or a World War II world, the direct object is long-term rates, which you can influence by being a big buyer, being a big bid for long-term bonds, mortgages, or, as we said in principle, anything else. I think William McChesney Martin was right, that there’s more distortion in resource allocation and in economics from trying to manipulate the long rates than there is from the short rates. Although, both are important.


The other distinction is, of course, real rates versus nominal rates. The real rates, just think about the nominal rate minus the inflation rate, are now up to, more or less, zero, a little over zero on the short run and were run at negative real short-term rates. And the nominal rates were close to zero, and inflation was two percent.


That gives you a negative real interest rate of two percent -- a real interest rate of minus two percent. That’s very distortive to financial markets and has something to do with what has been wittily called the “everything bubble.” But the other thing it does is it robs money from savers and gives it over to people are leveraged, who get, basically, free financing of their levered positions. When I mentioned in my comments that everything the Fed does is political, you couldn’t get more political than that: robbing the savers to enrich the speculators.


Wesley Hodges:  Well, thank you both for your thoughts on that. It looks like we do have two more questions in the queue. So next caller, you are up.


Caller 2:  I’m trying to understand a little bit about how interest rates effect and impact the deficit in the national debt. It’s my understanding that when you increase the -- when the Fed increases the interest rate, that would also increase the rate that -- the interest rate that the Treasury pays and will affect the annual deficit and, consequently, affect the national debt. And if I’m right about that, and hopefully you’ll enlighten me, then why do we blame the President and Congress for the deficit when the Fed has a big impact on what the deficit will be?


Norbert Michel:  That’s kind of what I was getting at, though. This is -- and it is true that the Fed has an influence over credit markets and, therefore, interest rates. But again, I would caution everybody that it’s not the case that the Fed decides “Oh, I know what we’re going to do. We’re going to make interest rates go up to four percent.” It just doesn’t work that way. And you can think about it as sort of like the general return -- rate of return in the economy. If the economy is more productive and things are looking up, you can earn a higher return in the economy in general. Interest rates are going to go up.


And if it’s not because of inflation, which the Fed is definitely responsible for, then that had nothing to do with what the Fed did. And the Fed could even be raising their target as interest rates are going up, and all they’re really doing is following rates and maintaining the supply of credit at the demand that is in the economy. So it’s not the Fed’s fault. I’ll be even blunter. Because Congress and the administration have undertaken so much debt, if interest rates go up, the Fed might not be able to do anything about that. And the fact that interest rates are going to go up is going to increase the deficit even more by requiring higher interest payments.


Alex Pollock:  I discussed -- well, that’s right. I discussed the dispute between Truman and Secretary Snyder and the Fed, which was going on in 1950 and 1951 in my comments. And that dispute was precisely about the question you raised. Namely, from the Treasury’s point of view, the Fed was going to make financing the government more expensive by stopping from buying government bonds and letting their interest rate rise. And they didn’t want that. And that’s a classic tension between the Treasury as borrower and the central bank as worrying about inflation. Now, one thing we should mention here is, to the extent that the debt is owned by the Federal Reserve, it’s a little bit different.


So there’s all the debt in the rest of the world, internationally and domestically, held by all various private parties. But there’s the debt held by the Federal Reserve itself. And on that debt, the Federal Reserve gets the interest rate from the Treasury. Out of that interest rate spends whatever it wants on its limos and buildings and everything and then gives whatever’s left, which is almost all of it, 98 or 99 percent, and gives it back to the Treasury. So to that extent, the Treasury gets back from the Fed what the Fed paid. And that’s a tricky part of this equation.


Caller 2:  So what percentage of the national debt is held by the Fed?


Alex Pollock:  Well, the Fed’s got a couple trillion, and debt held by the public is what now, Norbert, $18 trillion? Something like that.


Norbert Michel:  I think it’s just under 20, yeah.


Alex Pollock:  So something north of ten percent, I guess. Don’t believe our memories. You can easily find that number. It’s immaterial. And you were going to say mortgage backed securities.


Norbert Michel:  Right. Which, technically, are obligations of the U.S. government now, even though that’s not on budget. So if you wanted to count that, then it would be higher. I know that at some point, in the aftermath of the crisis, the total that they held was up to around a third, just under a third. So it varies a little bit, but it’s substantial.


Alex Pollock:  The mortgage backed securities and the Treasury bonds together that the Federal Reserve owns total $3.9 trillion, as of now.


Wesley Hodges:  Well, very good. Thank you so much for your question, caller. We do have another question in the queue. Here’s our next caller.


Bob Popper:  This is Bob Popper in Washington. I have heard from you all the things that the Fed’s not supposed to do, and it sounds right to me. So a simple question, what is it supposed to do? I take it will decrease the money supply so as to keep prices stable. I take it that it will provide liquidity in times of runs on banks. Although, I’ve heard that even that’s not necessary, and they never had runs in Canada during the Great Depression.


Norbert Michel:  It’s true.


Bob Popper:  If you were defining it, what would you make it do?


Norbert Michel:  Alex, do you want me to go first or do you want to go?


Alex Pollock:  You go ahead, and then I’ll tell you what I think the six mandates of the Fed are.


Norbert Michel:  Okay. If I were king for a day but we were stuck with the Fed and I had to say, “What are you going to do?” then I would tie it to targeting a nominal spending metric. So I don’t think price stability, in and of itself, is the right goal. There are some times when prices should fall. It depends on what productivity is doing. If overall productivity is going up, prices should be coming down. And price stability works against that. So that distorts markets. Another way of saying that is that sometimes mild deflation is good, and price stability prevents that, certainly the way they’ve defined it.


So I would come about this and say, basically, the only thing the Fed can do is handle nominal rates -- or I’m sorry, nominal variables. And the one that requires the least amount of -- I’m sorry. The one that requires worrying about the least amount of things that it can’t know and fixes the sort of knowledge problems that we face with data would be something like a nominal spending target. So that’s what I would do.


Alex Pollock:  If you look back at the original Federal Reserve Act, it defines the purpose of the Fed very correctly as allowing an elastic currency. Elastic currency was a term of the time. What does that mean? That means when you get in trouble, lend people money so that you’ve financed the crisis, or as an old saying goes, the private banks financed the boom and the central bank finances the bust. That’s quite accurate. It turns out -- or we also know that as the lender of last resort. It turns out the Fed actually is very good at being the lender of last resort as it was in the last crisis and ones before that.


So the original notion was elastic currency, lender of last resort, and being the sole people who can print up money. In fact, they can do that. Doing it well may be a different question, but that’s for sure. If you go on to the act I mentioned, which is the Federal Reserve Reform Act of 1977, that’s the source of the famous dual mandate of the Federal Reserve. But the dual mandate is really a triple mandate because what that act says is the Fed has three mandates: stable prices—again, not steady inflation—stable prices, maximum employment, and the third, which everybody always forgets about, according to the act is moderate long-term interest rates. And I suppose it’s always forgotten because nobody really knows, probably, what that means, moderate long-term interest rates. But it’s in the black letter law.


So that gives us four so far. But there are two more. The next one, the fifth, is the Fed’s job is to be the manager of the banking club, is the way that Charles Goodhart, a great student of central banks, put it. And that is -- as we think about the Fed, that’s one of the most important things it does. It keeps the banking system going along and tries to manage the behavior of the banking club, especially the big banks.


And finally, sixth and most important mandate of the Fed is financing the government as needed. This they never talk about because it’s sort of embarrassing to them. But in fact, it’s the biggest thing that all central banks are there for, and it’s why every government has a central bank because it makes financing the government, when you need it, easy.


You just sell the bonds to the central bank. The central bank prints up the money. This pattern goes all the way back to the foundation of the Bank of England in 1694, I think it is. It was in the history of the Fed. The Fed made its reputation by financing the first World War and then the second World War and subsequently. And it’s doing it again, now, as we talked about, the $2.5 or something trillion of financing the government. So that’s my list of the six things the Fed does.


Bob Popper:  Well, thank you. Just a quick follow up to Professor Michel. Nominal spending of what? Who’s nominal spending?


Norbert Michel:  Aggregate spending, total spending in the economy.


Alex Pollock:  Otherwise known as GDP.


Norbert Michel:  So not real, but nominal. I know this kind of gets a little wonky, but basically --


Alex Pollock:  We wouldn’t want that, Norbert.


Norbert Michel:  It’s too late I guess. Basically, it’s saying not just targeting the price level. It’s the price level -- it’s prices times real output. So it’s the total nominal spending that you get in the economy in aggregate. And that, I would argue, would be a better outcome. I would prevent it from doing a lot of the things that Alex -- that are as mandate, as Alex correctly pointed out.


Wesley Hodges:  Well, very good. Thank you very much, caller, for your question. Appreciate the back and forth there. I turn the mic back to Alex and Norbert. Do you have any further thoughts you want to dive into before we wrap up the call today?


Norbert Michel:  I guess I’ll just -- I’ll elaborate on where I ended there, just for a second, because I’m anticipating that someone is still listening to that. But what  I’m going for there with what I’m saying about targeting nominal spending is I’m going for a neutral arbiter of the money market. So I don’t want the Fed to be juicing the economy. I don’t want it to be crushing the economy. I don’t want it to be buying whatever federal debt there is, financing the deficit. I want them to be supplying the amount of money that the economy needs, but not more than that and not less than that.


So to be a little bit more particular, I believe that the best way of doing that is to use a nominal GDP or a total nominal spending kind of target because I think that that’s most synonymous with supplying the amount of money that the demand is requiring, that money demand is required. And it’s an approximate thing. It’s certainly not perfect. But I do think it would be better than what we have.


Alex Pollock:  My final thought is to tell a story, which Norbert has heard before, but it’s such a good story. We need to think about it. Dionysus, the tyrant of Syracuse in ancient times, got into debt to his subjects, the way sovereigns often do, and ran out of money and couldn’t pay his debt. So he regally proclaimed a law that all of the money, that is to say the silver coinage, in Syracuse had to be turned in to him, upon penalty of death. According to the story, once he had all the silver in hand, he took every one drachma coin, re-stamped it two drachmas, and paid off his debt. And in doing so, he became the father of all central banking.


Wesley Hodges:  Beautifully put, Alex. Thank you.


Norbert Michel:  It’s a good story.


Wesley Hodges:  We do want to thank Alex and Norbert. Thank you so much for being here today. On behalf of the Federalist Society, I’d like to thank you for the benefit of your valuable time and expertise. We welcome all listener feedback by email at info@fedsoc.org. Thank you all for joining. Our call is now adjourned.


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