Federal Reserve Chair Janet L. Yellen will head to Capitol Hill today to deliver the Fed’s semiannual monetary policy report to Congress. Yellen’s leadership and the state of the economy are on the agenda. At stake is the Fed’s ability to ward off a hostile Republican Congress, emboldened by the election of Donald Trump as president and eager to impose change on the Fed.
Why are lawmakers so critical of the Fed? And what are the prospects that Congress will reform the powers and governance of the central bank?
Let’s set the scene
President Trump and the Republican Congress inherit a Fed shaped by the Obama administration and the global financial crisis. The Fed’s main monetary policy levers still bear the unconventional scars of the financial crisis: rates near zero and a balance sheet ballooned with trillions of financial assets. Although a mix of inflation hawks and doves populates the decision-making Open Market Committee, Republicans cannot immediately reshape the Fed: Yellen’s term as chair will extend into early 2018 and Fed Board governors hold 14-year terms.
Even with the Fed’s long-term appointments, Trump will soon have three vacant board seats to fill, a supervisory vice chair to appoint and, most important, a decision to make on replacing Yellen. If the Trump White House swiftly selects nominees and a Republican Senate finds time to confirm them (two big ifs), Trump and Republicans can recast the board’s monetary and regulatory perspectives within the year.
This is why the Fed remains in lawmakers’ crosshairs
Neither party has a monopoly on attacking the Fed. The figure below shows each party’s share of the proportion of Federal Reserve-related bills introduced in each Congress since 1946. Republican attention to the Fed grew only over the past decade, especially in the wake of the financial crisis. At the same time, Democratic interest waned, probably because President Obama had appointed the entire Board.
As we show in our forthcoming book, “The Myth of Independence: How Congress Governs the Federal Reserve,” criticizing the Fed is a time-tested strategy for lawmakers eager to avoid blame for a sour economy. Reliably over the past century, and almost always around recessions or economic crises, lawmakers blame the Fed — and then seek reforms that, counterintuitively, hand the Fed more power.
Republicans have been particularly critical of the Fed’s recent decisions. In the wake of the global financial crisis, the Fed’s dominance created a useful foil, channeling Republican anger about the weak economy and the Fed’s regulatory performance. At the same time, Congress and the president engaged in fiscal theatrics. The GOP threatened to default on the debt and shut down the government, leaving the Fed responsible for engineering the recovery.
Nearly a decade after the crisis, an improving economy has hardly mollified GOP critics. The economy has nearly reached the Fed’s congressionally chartered mandates for stable prices and maximum employment, but low rates, wages and growth continue to fuel GOP attacks. Most Republicans want the Fed to be more transparent, supporting a more invasive audit of Fed decisions. And many Republicans think the Fed has too much discretion. They advocate lashing the Fed to a more formulaic approach to setting monetary policy.
Democrats tend to be more supportive of the Fed. When Republicans attacked the Fed during the Obama years, Democrats largely defended the Fed’s unconventional policy choices, especially when blanket GOP opposition to additional fiscal policy made the Fed’s job even harder.
Still, Democrats today have upped their criticism of the Fed. Some question the optics of paying banks interest on the reserves they hold at the central bank. And Democrats bemoan a lack of diversity across the 12 regional reserve banks, calling for greater transparency and better board oversight of hiring.
Deeper economic problems abound, including income inequality, a job market failing to attract key cohorts into the labor force and persistently low productivity — although these are not issues that the Federal Reserve is programmed to resolve. Separately, there is bipartisan concern about the Fed’s willingness to aid Wall Street, seemingly at the expense of lawmakers’ constituents on Main Street.
Where does Trump stand on the Fed? Early in the campaign, he praised Yellen for keeping rates low. In the fall, he accused Yellen of playing politics with rates to help elect Hillary Clinton. Recent presidents have refrained from commenting on monetary policy. But presidents typically prefer accommodative monetary policy to help juice the economy come election time.
Will Congress reform the Fed?
Judging from history, today’s political economy weighs against major reform of the Fed. Below we use the 100-year history of changes to the Federal Reserve Act to simulate the likelihood of reform as a function of party control, the duration and severity of recession and conventional macroeconomic indicators. With Republicans in control of Congress and the White House, chances for reform should rise.
Still, reform is unlikely in good economic times. Revisions to the Federal Reserve Act more often follow crisis, when lawmakers seek to deflect blame for a struggling economy. By traditional macroeconomic measures, today’s calls for reform coincide with growth and inflation that have picked up enough for the Fed to start a gradual sequence of interest rate increases. Despite unified Republican control, history suggests that the chances for reform are low.
Notably, Republicans’ preferred changes run counter to past currents of reform. Centralizing greater amounts of authority in the board has in the past been the norm. In contrast, GOP proposals today appear far more punitive. Republicans advocate decentralizing reforms that limit the board’s discretion, devolve power to the Fed’s regional reserve banks and give Capitol Hill a bigger check on board activity.
Will the GOP continue to pursue these reforms even as the economy improves and their party takes ownership of Fed appointments? Republicans’ ideological goals are well served by weakening and decentralizing Fed power, counter to decades of reform. But their partisan interests might better be advanced by following past patterns to empower the Fed. That way, lawmakers can replay the blame game when the next inevitable recession occurs.
Given slim congressional majorities and only limited Democratic support for GOP proposals, major change remains a long shot. In the meantime and on behalf of the institution, Yellen will continue to shoulder the blame heaped on the Fed by her legislative bosses.
Sarah Binder is a professor of political science at George Washington University and a senior fellow in governance studies at the Brookings Institution.
Mark Spindel is founder and chief investment officer at Potomac River Capital LLC, a Washington-based investment firm.
They are co-authors of “The Myth of Independence: How Congress Governs the Federal Reserve,” forthcoming from Princeton University Press this summer.