The Institutional Structure of the Federal Reserve

With a Wall Street Journal Op-Ed (ungated here) from Senator Elizabeth Warren, and a long Manhattan Institute essay last year by Dan Katz and Stephen Miran, the latter CEA Chair and Fed Board nominee, both ends of the horseshoe are calling for fundamental reform at the Fed.

Miran and Warren don’t disagree either on diagnosis or on cures as much as you might think. The politically impossible has now become probable. Long dormant issues of the institutional and legal structure of the Fed could suddenly be reopened. But, since it long seemed settled, the structure of the Fed has not been a central concern of monetary policy analysts. We need to think hard and fast. This could be a well-considered reform, or it could be an institution-gutting disaster.

(Good recent writing on this issue includes How Congress Designed the Federal Reserve to Be Independent of Presidential Control by Gary Richardson and David W. Wilcox in the Journal of Economic Perspectives, and Paul Tucker’s book Unelected Power: The Quest for Legitimacy in Central Banking and the Regulatory State, Princeton University Press. David Beckworth interviews Miran and Katz. I don’t have set ideas on this issue, so this writing is a bit exploratory.)

The Fed has since 2008 much expanded the nature and range of its activities. It has suffered some rather unfortunate outcomes, such as the surge of inflation and the SVB failure. Those might be mistakes or not, but they at least invite some inquiry as to what happened and whether a different decision-making structure could do better.

Why is a central bank independent at all, not like the Treasury a department of the administration, or even semi-independent like other agencies such as the EPA and SEC? Economists cite “time consistency” problems unique to monetary policy, which I’ve explained elsewhere. Katz and Miran, like most analysts, cite political precommitment: “central bank independence is intended to allow the pursuit of long-term goals despite short-term political vicissitudes.” The government would rather tie itself to the mast than face the temptation to goose the economy ahead of elections. But this argument less obviously applies uniquely to monetary policy. Congress and Administration face plenty of such temptations, starting with stimulus checks. Shouldn’t taxing and spending also be delegated to independent technocrats? Well no. But let’s spell out why.

Independence in a democracy is a limited grant. The Fed cannot stoke inflation by giving people money, nor stop inflation by confiscating money. Those would work, but taxing and spending must remain the providence of more political (not necessarily a bad word) or accountable branches of government. The Fed cannot independently decide that it wishes to stop the climate crisis, end inequality, reverse trade deficits, or bring back manufacturing.

Independence must compromise with accountability. Independence slows down the popular and political will but does not stop it. Independence comes with a limited mandate (price level, employment, and financial crises, nothing else), limited tools (originally, short-term interest rates and small treasury purchases), and periodic review including appointments. An agency can be more independent the more its activities do not resemble transfers, as that is the essence of politics. Stop clutching pearls, it will be a compromise and the question is how to structure this compromise.

Katz and Miran want a “central bank that is insulated from the day-to-day political process while maintaining a level of accountability that a democratic society must demand,” and later “enhancing its accountability and democratic legitimacy.”

My central objection: Katz and Miran have a long and well expressed list of complaints about the Fed’s recent behavior. These come down, really, to complaining that “the Fed has gradually become more political,” echoing too much to the other party’s wishes when it was in power. That could reflect lack of independence, or more likely that the Fed’s preferences mirrored those political winds. But Katz and Miran’s reforms offer more “democratic accountability,” explicitly removing independence, and placing Fed officials under the thumb of the President would seem to mean more politics.

My instincts lie in the opposite direction: Restore Fed independence by restoring limits on its activities. If it’s interfering politically in fiscal policy, credit allocation, bank regulation, and other areas, then tighten the limits on mandate and tools rather than accept the current much broader set of interventions but add more political direction — sorry, “democratic accountability.” I prefer the “democratic accountability” to lie in better defining the rules of the game, and less in telling the Fed which piece to move.

More generally, “democratic accountability” is the sort of phrase I expect from the far left. We don’t live in a democracy. We live in a constitutional republic, with strict limits on government power. We don’t vote 51-49 whether the city should seize my house and turn it into a homeless shelter. I have (some!) property rights. We don’t vote every 6 weeks on interest rates up or down. If you want “democratic accountability,” then why not? The Fed is a carefully constructed republican (small r) institution, that does a lot of collecting information, bringing diverse communities together, representing many people’s wishes. Votes are not the only way to aggregate preferences, produce consensus and legitimacy.

Katz and Miran seem a bit enthralled by the possibilities, now that their party is in power. Yes, have “more democratic accountability” since our guy won, to let him change the Fed more quickly. But what’s good for the goose is good for the gander. If you envision structural changes to the Fed, you must envision them when Gavin Newsom is president, Elizabeth Warren is in charge of Congressional Fed oversight, and somebody even more progressive than Newsom is governor of California. Do you really want quite so much “democratic accountability” now? Be careful what you wish for, you just might get it. Given the natural leftward bias of DC technocrats and academics, and that eventually power will shift, the same Fed will bend more quickly to the next administration’s wishes too.

Katz and Miran wrote a whole year ago, before the Trump Administration’s desire to intervene in the Fed’s decisions and the economy more generally was clear. Also, the classic issue is now heating up: President Trump wants lower interest costs on the debt. Still, it’s an articulated view worth thinking about.

Reforms

Katz and Miran propose to

dispense with the current structure and the illusion of independence that it provides, and instead introduce transparency and accountability throughout the Federal Reserve system while restraining dominance by any center of political power. …These reforms should produce greater insulation from the day-to-day political process—enabling superior monetary outcomes—than the current construct of false independence.

We propose enhanced democratic oversight and accountability for Fed officials, while also imposing reforms that would reduce the incentives for them to pursue partisan political agendas. Our proposal makes the Board of Governors significantly more accountable to the president. We then check that influence with employment restrictions for board members and with a reform of the Reserve Banks that increases their influence on the FOMC and their democratic legitimacy. …

This seems like boilerplate, but read it carefully. In the first paragraph, they throw independence out the window. In the second, “more accountable to the president.” It’s an interesting and I think a bit misleading choice of words.

I’m allergic to buzzwords. “Democratic oversight and accountability” “democratic legitimacy” “monetary federalism” are not worthy goals on their own. One person’s “democratic accountability” is another persons “political hack.” One can be “accountable” without doing what the president says. For example, Congress might mandate a price level target, and the President in charge of holding FOMC members “accountable” to that goal and not expanding the Fed’s remit. But that would preclude acting under the direction of the president, say to lower interest costs on the debt.

In any case, how in the world does that “produce greater insulation from the day-to-day political process?” “Employment restrictions for board members” and “reform of the Reserve Banks” are proposed to take the place of independence.

Employment restrictions

Katz and Miran worry that Board members will time their resignations to favor the party in power, and to get themselves juicy administration jobs. They think long terms in office thus give incentives to be more, not less political. The founders, who gave judges lifetime tenure, might disagree. Katz and Miran’s reform:

Congress should amend the Federal Reserve Act to shorten all board members’ and Reserve Bank leaders’ terms to a single term of eight years…. board members and Reserve Bank leaders should be subject to at-will removal by the president to ensure their accountability to the democratic process….[Board Members] should be prohibited from serving in the executive branch for four years following the end of their term.

For centuries, governments have bandied about term limits and revolving doors vs. the benefits of long and varied experience. I don’t see a resounding success for term limits and employment restrictions. Political appointments are not high paying sinecures anyway. Most FOMC members retire to banks and hedge funds, not to politics.

The ECB president serves a single 8 year term, and they seem to want to go on to an independent public life. This fixed term has if anything led to more rather than less mission creep. The former head of the Bank of England is now Prime Minister of Canada. Not serving as a UK government functionary did not seem to lower his interest in central bank climate change efforts either.

Yes, Katz and Miran envision firing at will, and indeed

a newly elected president will likely nominate all seven new board members in the early portion of his term.

This is somehow going to produce less political decision making and less see-saw in policy across administrations?

I worry more about who presidents place on the board than what those people do afterwards, and whether essentially one more set of ethics rules will dramatically change their incentives to vote one way or another on interest rates. Getting smart people to take FOMC or reserve bank president jobs is not easy. The rigors of senate confirmation, ethics rules that are now gotcha traps rather than actually stopping corruption, the chance of partisan character assassination, and the fact that this isn’t the greatest job in the world — it really is public service — weigh heavy.

In short, shorter terms and post-Fed employment restrictions seem to me like very weak countermeasure for the loss of independence.

Reserve Banks

Their deeper proposal is “Nationalization of the Reserve Banks.” They write, correctly in my view,

The regional structure of the Federal Reserve system is an important feature of U.S. monetary policy and helps avoid myopic policymaking—a risk of large, centralized systems…..

But their reform proposes that

to increase their [reserve banks] insulation from day-to-day political pressures in Washington, their boards of directors should be selected by the governors of the states in each district….Boards of directors would continue to select the leaders of the Reserve Banks…Reserve Bank executives should also be removable at will by the president

This proposal seems like the ultimate in adding politics in order to reduce politics. Consider the Federal Reserve bank of San Francisco, currently run by the very capable Mary Daly. Imagine who Governor Gavin Newsom might appoint to the board, and wish to see appointed to head the San Francisco Fed. (The district includes other states, but whether by population or congressional representation, CA will be a big voice.) I see a sinecure for state-level political allies. A political figure such as Kamala Harris might be a predictable outcome to head the SF Fed. That’s what “democratic legitimacy” means. Whatever her strengths and weaknesses, does anyone think a figure like Kamala Harris would produce less politicized and more competent monetary policy than Mary Daly?

This, really emblematic of the whole proposal, seems to me to miss the central point of the Federal Reserve, and really of our government in general. The Federal Reserve is constructed as a consultative, information-gathering institution. It carefully solicits the input from a wide variety of constituencies and regions, including agriculture, industry, small and large business, consumers, and more. A board seat is reserved for a community banker, for example. That wide forum for input gives the Fed its “democratic legitimacy.” The architects of the Fed thought hard about listening, consultation, and buy-in, given the controversies over banking, central banking, and finance that permeated the 19th century.

Now, you might say, let them all badger the governor to appoint who they like on the reserve bank boards. Funnel information through the “democratic” political process. But that is a much weaker consultation, and funnels it all through partisan and party politics, especially today. A Republican banker or car dealer in Fresno will get a solid hearing in Mary Daly’s San Franciso Fed. Will he or she be heard by the SF Fed headed and staff appointed by Kamala Harris, with a board picked by Gavin Newsom? Just how many gubernatorial elections will be won and lost in California over which political cronies Newsom appoints to the SF Fed board?

“Democratic” can mean “majoritarian.” Win an election 51-49, shove it down their throats. Our government is elaborately constructed to preserve the rights and voices of electoral minorities. You have another chance, we won’t take away our business and basic rights (too much).

A revamped regional Reserve Bank system will possess newfound democratic legitimacy, rather than reflecting private special interests, as it currently does

We’re all a “special interest.” And the Fed does have to respond to the “special interests” of banking and finance, which in turn serve us all. Does it really do any good, if you think the know-your-customer-rules are killing a community bank, to say “go vote for a different governor?”

some tweaks to the map of Federal Reserve Districts would be required… so that the system is not gerrymandered to favor Republicans or Democrats.

Given the current brouhaha over “tweaks” to Texas’ and California’s congressional districts, given the Supreme Court’s view that gerrymandering for political advantage is constitutionally protected, good luck with those “tweaks.”

Congressional oversight

Katz and Miran also want greater Congressional oversight.

While the Fed is a creation of Congress, its congressional oversight regime is significantly less rigorous than that of other government agencies—even so-called independent agencies.

The number one method of “oversight” is budget authority, and Katz and Miran want Congress to gain and use that authority

The Fed’s operating budget should instead be brought within the congressional appropriations process. This appropriation should be done on a five-year basis, in order to guard against the chance that annual budget negotiations create an opportunity for undue political influence into the Fed’s operations.

This seems guaranteed to lead to more political decisions. Lower interest rates, lend more to our “communities,” subsidize manufacturing and exporters, or we chop your budget. Are budget authorizations doing a good job of keeping politics out of other agencies?

More importantly, I think,

Beyond the budgeting process, ongoing congressional oversight of the Fed should be significantly expanded. … The Fed’s required reporting on the conduct of monetary policy is formulaic, and its monetary-policy operations are exempt from scrutiny by the Government Accountability Office or a fully independent inspector general.

Other countries have formal inflation targets, and their elected officials quiz the central bank governor about why the inflation target has not been achieved. It could go wrong. Would Congress grill the Fed over “why are you exceeding your mandate” rather than “why don’t you exceed your mandate some more to help my constituents?” Is the current oversight poor because Congress doesn’t have enough power, or because Congress and their staff don’t ask very good questions?

In any case this seems like the most important proposal.

The ideal of audits, inspector generals, etc. is popular. I don’t get what they would do for monetary policy. The FOMC decides to pay 4.25% interest on reserves. It pays 4.25% interest on reserves. What is there to audit? The Fed’s books are pretty transparent.

Separating bank regulation from monetary policy

bank regulation and supervision should be cordoned off from monetary policy…The board’s authority over bank regulation should be stripped and instead vested in the vice chair for supervision, who should report directly to the president and maintain a seat on the board. Such a change should apply to the entirety of the bank regulatory function and personnel at the Fed.

There is a case that bank regulation isn’t that different from, say, environmental or labor market regulation, so why should it be structured differently? However, it’s hard to get excited as the EPA, SEC, department of Labor, and the rest of the alphabet soup aren’t doing a whole lot better than the Fed under Dodd Frank.

My most optimistic take: I hope someday someone calls out the failure of the Basel/Dodd-Frank approach and directs a massive cleanup. This is unlikely to happen under an “independent” Fed. Independence also means cautious, carefully guarding independence, and unwilling to challenge the politically powerful banks. It would take a hard-charging administration with strong influence at the Fed to bring this about. This sort of vigor is I think the best case overall for more political influence at the Fed.

But once the other Katz and Miran proposals have come in to being, the Fed is no longer independent at all. So the goal is already achieved, financial regulation is like every other agency. And the weird structure of two bosses doesn’t make that much sense. Shouldn’t one person be in charge of the Fed, the way one person is in charge of Treasury?

Already, we have in front of us the spectacle that under the current “Chinese wall” between regulation and monetary policy, the stress tests were asking what happens if interest rates fall, while the FOMC and everyone who reads a newspaper knows that interest rates are about to rise. Should they talk less?

Katz and Miran separate bank regulation from crisis fighting, which is wise conceptually, but they want an extra crisis-fighting position, which I find dubious.

the Fed’s crisis-fighting responsibilities should be shifted away from the board. … Congress should redesignate one of the existing Board of Governors positions as a new vice chair for crisis response….

…in the event that the U.S. president declares a financial emergency, the vice chair for crisis response will assume authority for all 13(3) programs and any other asset purchases other than federal government obligations. In exercising this authority, the vice chair should report directly to the president. Unlike with bank regulation, the creation of asset purchase programs should still be subject to a vote of the FOMC, as such programs have significant monetary implications, in addition to their fiscal qualities.

The authority of the vice chair for crisis response—including any lending or asset purchase facilities established pursuant to their authority—should last for only three months, to ensure that crisis facilities are only for true crises. Facilities should be renewable only with congressional authorization for another six months, which Congress could then renew successively.

This is important. The Fed was instituted primarily as lender of last resort. There is a classic argument that the lender of last resort should be the central bank. Only the central bank can print money and thus guarantee with 100% certainty that “liquidity” (bailouts) will always be there. Each crisis is different. Central banks calm the waters by saying “whatever it takes,” and having the whatever in hand. The lender of last resort now extends to many other financial assets.

On the other hand, moral hazard is only contained by hard rules on what the central bank cannot and will not do, no matter how badly it wishes to do after the fact.

Three different warring chiefs at the Fed, with warring staffs that cant’t talk to each other, with the “crisis response” head suddenly doing whatever the President wants, but still subject to board approval, does not look to me like a great structure for accomplishing either goal. It also looks like a recipe for lawsuits.

We need to think hard about crisis response, what the Fed can and can’t do, whether it should purchase assets at all, the terms of bailouts. This does not seem like the right answer to that question.

Warren

I was prompted to read Katz and Miran and write this post by Elizabeth Warren’s interestingly similar op-ed,

…the central bank needs more transparency and accountability.

the central bank has generally rebuffed congressional oversight.

The Fed’s ability to conduct monetary policy without fear that the chairman will be fired by an angry president is a bedrock of our economy. But independence doesn’t mean impunity.

First, make the Fed’s inspector general an independent watchdog.

We can further bring accountability to the Fed by rethinking the role of the 12 regional reserve banks…Reserve bank presidents are selected by these boards behind closed doors without much transparency or public input. Ending these practices would improve the Fed’s public legitimacy.

The Fed is one of the most powerful institutions in our economy—and one of the least accountable. ..The only way forward is to pursue true reform.

Strange bedfellows.

Warren has some similar complaints (I deferred Katz and Miran’s)

It’s time to rein in the ways the central bank subsidizes Wall Street, from its quick reflex to bail out financial markets to its decision to change monetary policy by paying interest on bank reserves and making similar payments to shadow banks.

I agree with the former, and how the Fed has squashed competition in favor of big banks. I understand that interest on reserves comes from interest on the Fed’s treasury assets, so the Fed is just a giant money market fund that turns its profits over to the Treasury. Senator Warren does not, and it shows some of the simple misunderstandings by sophisticated people that may escape once the Pandora’s box of Fed structure is opened.

Another question is whether the Fed is capable of doing its job to regulate our biggest financial institutions and keep our system safe. …The Fed missed Silicon Valley Bank’s interest-rate vulnerability…. If the Fed can’t or won’t keep our financial system safe, Congress needs to step up with stronger rules.

SVB is a very significant mistake because it was so simple. The army of regulators, with their hundreds of thousands of rules could not see the elephant in the room of plain vanilla interest rate risk combined with uninsured deposits. Warren wants more rules, written by Congress. I see in this proof that risk regulation can never work.

The inflation surge following the pandemic exposed just how ineffective the Fed’s interest-rate hikes are in countering supply-induced price increases, while the persistent racial disparities in the unemployment rate underscore how the central bank has failed to promote a stronger economy for all.

So Warren is aware of the Fed’s limited power over inflation. Dear Katz and Miran, once there is “more accountability,” the Fed will be back to eliminating “racial disparities.”

The Fed also needs stronger ethics rules and enforcement to prevent senior officials from abusing their positions to juice their personal wealth.

Katz and Miran also complain about ethics kerfuffles. To me, I see an ethics system that is completely broken, fussing over minutiae while billions are transferred legally.

Trying to track down more Warren specifics, I ran in to more congressional action on the way, such as the

Federal Reserve Transparency Act of 2025

This bill directs the Government Accountability Office (GAO) to complete, within 12 months, an audit of the Federal Reserve Board and Federal Reserve banks. In addition, the bill allows the GAO to audit the Federal Reserve Board and Federal Reserve banks with respect to (1) international financial transactions; (2) deliberations, decisions, or actions on monetary policy matters; (3) transactions made under the direction of the Federal Open Market Committee; and (4) discussions or communications among Federal Reserve officers, board members, and employees regarding any of these matters.

How do you “audit” “discussions?” One can, I guess, bring the Fed to a complete “transparency” and “ethics” standstill.

From here

Today, Congresswoman Maxine Waters (D-CA), the top Democrat on the House Financial Services Committee, and Senator Elizabeth Warren (D-MA), announced they reintroduced the Federal Reserve Racial and Economic Equity Act, legislation that would require the Federal Reserve to use its existing authorities to close racial employment and wage gaps and report on how the gaps change over time.

‘‘The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall exercise all duties and functions in a manner that fosters the elimination of disparities across racial and ethnic groups with respect to employment, income, wealth, and access to affordable credit, including actions in carrying out—

‘‘(1) monetary policy;

‘‘(2) regulation and supervision of banks…

‘‘(3) operation of payment systems;

‘‘(4) implementation of the Community Reinvestment Act of 1977;

‘‘(5) enforcement of fair lending laws; and

‘‘(6) community development functions.’’.

Dear Katz and Miran: This is “democratic accountability,” just a few votes away. Is this really what you want?

Katz and Miran’s Complaints

Katz and Miran’s list of complaints about the Fed is well expressed. You may not agree with all of them (I don’t either), but you must admit they are plausible and bear consideration. There is merit in some of Senator Warren’s complaints too. Undeniably, the Fed of 2025 is very different and much expanded versus the Fed of 2007, and it does bear consideration by elected officials if the new implicit institutional structure should remain as it is.

What assets a central bank can buy and on what terms, and who it can lend to and on what terms, have always been a crucial part of the institutional limitations on central banks. Historically, some central banks were forbidden to buy treasury debt, to avoid financing deficits. The Fed in 1913 was charged with “rediscounting” commercial papers. Others have been forbidden to buy private debt, to avoid politicized financing.

Asset purchases have changed:

during bouts of financial instability… the Fed created Section 13(3) facilities…[that] allow the Fed to purchase virtually any debt instrument…Facilities have covered asset-backed securities,… commercial paper,… municipal bonds,… and direct loans to small businesses…

This is political:

Who gets credit, how much, at what price, and with what collateral or other requirements? Should haircuts… or borrowing rates on bonds backed by student loans be higher or lower than those backed by used cars? What about on loans to small businesses on Main Street? And how do we account for—or determine—differences in creditworthiness? These are unavoidably political questions, but they are decided by Fed officials claiming to be nonpolitical.

But parse the response. In these joint Treaasury-Fed facilities,

[T]he [Treasury] secretary cannot direct the Fed to channel credit to a particular segment of the economy. Oversight by an official accountable to voters is therefore limited, despite the political nature of the selection of winners and losers by credit rationing and deciding whom to infuse with cash by buying debt.

Wait, so the right answer is that we should keep this up, but the Treasury should tell the Fed who to subsidize with newly printed money? Isn’t the answer that fiscal policy and transfers should be the responsibility of Treasury alone, with Congressionally appropriated money, and the Fed should stay out of the business of propping up asset markets?

Like it or not, Large Scale Asset Purchases and QE are a big permanent and structural change, and worth consideration. LSAPs include mortgage backed securities and long term treasurys, with political ramifications. Supporting housing, but not, say, corporate debt, is an obviously fiscal and political decision.

Buying long-term treasury debt shortens the maturity structure, making higher interest rates flow quickly onto the government’s interest costs, a big fiscal decision. The major story for QE effects is “removing duration.” Well, the treasury sold duration for a reason. We need to decide who is in charge. I’ve been writing for a long time that Treasury should be responsible for the maturity structure of the debt. Katz and Miran agree

Since the American public is responsible for U.S. public debt, the maturity profile of debt should rest with the fiscal authority (Treasury), not the monetary authority (the Fed). … LSAPs have consequences for the maturity profile of debt held by the public that can interdict Treasury’s decisions about debt issuance.

Banking regulation has expanded enormously since Dodd-Frank

Bank regulation, too, has veered into outright political territory.

As the Fed has implemented successive Basel regulatory frameworks, it must weigh the riskiness of various assets (called “risk weights”)… This process involves making judgments about the allocation of credit to municipal or privately issued instruments. The Fed can waive various ratios in the Basel framework, but that is also a normative, political decision.

The ECB includes climate in its haircuts. But do we want more “democratic accountability” i.e. political direction of risk weights? Or do we want to remove the whole question by transitioning to abundant capital?

regulatory decisions related to bank mergers and resolutions… involve the Federal Reserve in unnecessary debates about market concentration and political economy.

One could argue with “unnecessary,” but certainly “unrelated to financial stability.” But is the less independent FTC doing a bang-up job of handling mergers? Is turning every bank merger into a contest for banks to slavishly butter up the current administration a good idea?

The separation between monetary and more inherently political fiscal policy is always difficult. Katz and Miran point to explicit Fed involvement in fiscal policy:

…For a decade, the Fed made explicit calls for more government fiscal stimulus because it was worried about undershooting its inflation target. Fed officials frequently ask Congress to address long-term budget problems; but whenever actual fiscal retrenchment materializes, they typically argue against it…. Augustine’s monetary heirs might as well cry,“God, give me fiscal sustainability—but not yet!”

More recently, during the pandemic recession, … Chair Powell urged Congress to take even more aggressive fiscal action, “to use the great fiscal power of the United States” to provide “direct fiscal support.”… Later, in October 2020,…Powell again urged Congress to go big, warning that “too little support would lead to a weak recovery.”…

the subsequent inflation created by excessive fiscal spending following the 2020 election suggests that his prescription was also mistaken, adding insult to injury.

An interesting observation:

the Fed appears to suffer from the same near-termism on fiscal matters as lawmakers: notably, Chair Powell refrained from calling for fiscal responsibility, spending cuts, and regulatory reform in 2021 and 2022, which would have assisted the Fed in bringing down inflation.

Indeed, I have heard lots of comments from Fed people to the effect of “we can’t talk about fiscal policy” when we discuss the inflationary impact of deficits, or the effect of shortening the maturity structure on interest costs. Yet when stimulus is desired, that fear disappears.

Still, I’m Mr. Fiscal Theory of the Price Level. The dream that monetary and fiscal policy can be separate lies on MV=PY describing monetary policy, and such small debt and deficits that seigniorage and interest costs don’t matter. I think the deficits of 2021-2022 did cause the inflation and that raising interest rates cannot lower inflation unless fiscal policy tightens to pay debt service costs. Either the Fed has to care about debt and deficits, or the Treasury and Congress have to own up to their effect on inflation and not think they can do what they want with fiscal policy and the Fed can always control inflation. Loud warnings to Congress that fiscal responsibility are important for the Fed to do its job on inflation would be appropriate. So I don’t think this is the answer:

The Fed has waded into the political arena and advocated political approaches when prudence would have dictated silence.

The Fed must take fiscal variables into account in setting monetary policy, but there is little reason for it to openly debate fiscal issues or call on Congress to adopt its preferred policies.

I’m not sure that “silence” or simply “take fiscal variables into account in setting monetary policy” will do the trick. It is true that the Fed lost a lot of credibility, that

The Fed politicized itself by wading into fiscal debates, and doubly so by doing it so one-sidedly.

Would more independence have helped? The Fed seemed to me all in — when fiscal policy wanted stimulus, inflation be damned, the Fed agreed, wanted more, and voluntarily printed up the money for the Treasury to hand out. This might have been a technocratic judgement, given a technocracy stubbornly imbued in a mid 1970s Keynesian mindset; or it might have reflected a lot of Democratic political sympathies inside the Fed. It does not seem that a reluctant Fed did not have enough independence to refuse the inflation-generating monetary blowout. And it does not seem that even more “democratic accountability” to the wishes of the Biden Administration, Treasury Secretary Janet Yellen, or the Congress, would have resulted in any less overblown stimulus or inflation.

Katz and Miran have three complaints under “mandate creep.” The third is the most obvious. When did “price stability” become 2% inflation forever, and we forget mistakes? Katz and Miran are mad about the FAIT framework. The framework is abandoned, but the authority to write it is not:

[T]he adoption of FAIT comprised a radical reinterpretation of the Fed’s price mandate—“stable prices,” as written by legislators—in which the Fed decided purposively to overshoot 2% inflation on a “sustained” basis…

They object to the policy,

Only an institution with self-confidence approaching hubris could believe that it could successfully manage such a policy, which is based on the impossibility of both accurately measuring inflation and precisely controlling its future course as to overshoot.

But they object more to the Fed’s authority to enact it.

[I]t is profoundly undemocratic and a significant overstep of its statutory authority for the Fed to adopt such an agenda on its own, without license from democratically elected representatives. ..This episode makes plain how the vagueness of the Fed’s statutory mandate is precisely why democratic oversight is essential: left to its own devices, the Fed can interpret the mandate any way it likes, in order to justify policies that are the exact opposite of what Congress envisioned.

I take the opposite implication. Rather than more “democratic oversight” over interest rate decisions, Congress should enact a stricter mandate. (Again, if you’re serious about “democracy,” let’s all vote every 6 weeks.)

I view the inflation target mandate creep more charitably. Congress wrote “price stability” decades ago. The Fed slowly interpreted this to mean 2% inflation, then 2% inflation and we forget about mistakes, then the asymmetric complex FAIT, and now a new framework. Congress’ silence is its acquiescence. Every time Powell went to Congress, legislators could have said “price stability means price stability!” They did not. Well, maybe Congress is waking up.

Still, I would rather Congress clarified the mandate than impose “democratic accountability” on the Fed’s decisions.

Second, Katz and Miran decry “mission creep.”

The Fed’s mandate has further expanded to encompass highly political issues outside its [traditional!] area of responsibility, such as climate change. Following the Bank of England… and the European Central Bank,… the Fed is introducing “climate-related” regulation… principles into the bank regulatory framework, an action that has drawn stern rebuke from dissenting members of the Board of Governors….

…the Financial Stability Oversight Council, of which the Fed chair is a key member, described climate change as its top priority in the immediate runup to the failure of SVB. Had the Fed been paying attention to the banking system’s interest-rate risk instead of climate risk, the system might have been spared significant volatility.

But here we have the conundrum. The FSOC is chaired by the Treasury Secretary. It is not “independent” by any stretch of the imagination. The Biden Administration declared a “whole of government” crisis like approach to climate change. They were voted in office having loudly made “climate crisis” a centerpiece of their policy. This is “democratic accountability” and “oversight!”

The Fed has also allowed,… inducements to discriminate on the basis of race to creep into its operations…. The Fed’s own website prominently displays… a breakdown of Reserve Bank directors by race and gender, including categories of racial classifications that the Supreme Court recently noted “rest on incoherent stereotypes.”… In 2020, the Reserve Banks collectively launched a 12-part series focused on the implications of structural racism in America’s economy…. The mere appearance of joining highly charged debates on the role of race in American society makes it harder for the Fed to maintain the political distance necessary to conduct effective monetary policy.

And that too was exactly what the “democratically accountable” Biden Administration wished.

The Fed didn’t object even quietly, so simple independence is not the answer either. The only answer that makes sense to me is limits on what the Fed can do, enforceably by electoral minorities, not just majorities.

Mandate creep at the Fed is not just a series of discrete unjustified endeavors that can be quickly reversed. Rather, it is symptomatic of a pernicious institutional culture that caused the attitude that “central banks are the only game in town,”

This is correct. In 2008, the Fed was perceived as the only competent agency that could move fast. It ratcheted up its interventions. The ECB has expanded similarly. (This is the point of Crisis Cycle). But after the crisis faded, nobody objected that we should create institutions better suited to those tasks —and maybe not empowered with the printing press, and maybe more “democratically accountable” ones.

More generally, the Fed, which began as lender of last resort, gradually took on the mantle of general purpose macroeconomic regulator. Katz and Miran pull punches here. The Fed once looked only at employment and inflation, per mandate, and only manipulated short term rates and bank reserves. Gradually, the Fed started intervening in all sorts of markets and directly or indirectly controlling long term bond prices, credit spreads, stock prices, and the prices of more exotic financial instruments. Academics and institutions such as the BIS have called for the Fed to tighten and loosen regulatory standards over time so as to “manage the credit cycle.” At least the Dodd-Frank act had the decency to say something went wrong. Now we just pat ourselves on the back with every river of money.

Katz and Miran’s first “mission creep” complaint is more subtle,

… As part of the Dodd-Frank Act, Congress created the politically appointed role of vice chair for supervision. By doing so, Congress recognized that bank regulation and supervision are intrinsically political and wanted such activities to be carried out by an explicitly political appointee.

Predictably, the Fed is following the pattern of other regulatory agencies:.. policies change from one administration to the next, and Vice Chair Michael Barr even blamed his predecessor of the opposite political party for the Fed’s supervisory failures that contributed to the collapse of Silicon Valley Bank (SVB) in March 2023….

So… Congress made part of the Fed more “democratically accountable” like other administrative agencies, and the result is, predictably, that banking regulations (and, more importantly, their application) change when new administrations come in to power and put new people in place. The answer is more “democratic accountability?”

In sum, I am sympathetic to many of Katz and Miran’s complaints. I think their reforms will make the complaints worse.

Subscription button: Note this substack will always be free.