Congress, the President, and the Federal Reserve: The Politics of American Monetary Policy-Making

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Congress, the President, and the Federal Reserve is a study of the politics of monetary policy making at the Federal Reserve--widely considered the most important and most powerful federal bureaucracy. Ostensibly, the Federal Reserve is independent of the political branches of government; however, Congress, the President, and the Federal Reserve clearly demonstrates-- from both a theoretical and empirical standpoint--how the preferences of members of Congress and the President impact decisionmaking at the Fed.

Current formal theories of the general policy-making process are utilized to construct an explanatory framework that identifies the mechanisms through which congressional and executive influence is exercised. The theoretical framework presented in the text also helps to explain the political dynamics of several of the most significant policy decisions of the Federal Reserve during the last half-century. In addition, this book provides a unique perspective on the manner in which Fed policymakers attempt to shield themselves from unwelcome political influence.

While the main focus of Congress, the President, and the Federal Reserve is monetary policy-making, it also speaks to the political nature of policy-making in a more general sense and provides a guide for the future study of the political dynamics in a wide variety of substantive policy areas. Thus it will interest not only political scientists and economists interested in monetary policy-making specifically but also those interested in the nature of public policy-making more generally.

Irwin L. Morris is Assistant Professor of Political Science, University of Maryland.

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Product Details

  • ISBN-13: 9780472088690
  • Publisher: University of Michigan Press
  • Publication date: 4/25/2002
  • Edition description: Reprint
  • Pages: 176
  • Product dimensions: 6.00 (w) x 8.90 (h) x 0.60 (d)

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Congress, the President, and the Federal Reserve: the Politics of American Monetary Policy-Making

By Irwin L. Morris

University of Michigan Press

Copyright © 2000 Irwin L. Morris
All right reserved.

ISBN: 0472109952

Chapter 1 - Introduction

The Federal Reserve System is perhaps the most controversial nonelected element of the government of the United States. Journalists and voters vilify it, Congress and the President seek to dominate it, and scholars argue about it. (Munger and Roberts 1990, 83)
Among federal bureaucracies, the Federal Reserve (or Fed) is at least first among equals. Though it is neither the oldest nor the largest federal agency, it has a greater impact on the course of everyday economic life than does any other bureaucracy or regulatory agency. Although the Fed has a number of important duties--acting as a clearinghouse for commercial banks, regulating certain banking activities, and printing and issuing currency--the Fed's most important responsibility is the conduct of monetary policy (the manipulation of the quantity of money in circulation). This responsibility also provides the Fed with the power to influence the national and international economy. As Newton wrote, "In America one institution, more than any other, controls the movement of money, prices, and the economy. That institution is America's central bank, the Federal Reserve" (1983, 10). In reality, "No one can afford to ignore the Fed" (Beckner 1997, ix).

That such a powerful institution would be a political animal in a political jungle seems obvious. But the politics of monetary policy-making were long ignored by students of the Fed, and only during the past 30 years--much less than half the Fed's life--have the political dimensions of Fed policy-making served as a focal point for research. During this time, scholars have suggested and developed a number of different perspectives toward the politics of monetary policy-making, and this multiplicity of theoretical viewpoints has led to a wide array of empirical analyses designed to evaluate the claims of various theories.

At the beginning of the research that would eventually lead to this book, I fully intended to conduct what would be--at least for a time--the definitive empirical evaluation of extant theories of Fed policy-making. As a graduate student in political science, I understood that work of that type was the substance of many a "good" dissertation. I also knew, though only half-consciously at the start, that making an original theoretical contribution was a far more difficult endeavor. During the months in which I submerged myself in the monetary policy-making literature, I became convinced that my intentions were misguided. I no longer believed that any type or quantity of empirical analysis would resolve the controversies over the politics of Fed policy-making. I came to realize that traditional perspectives toward monetary policy simply failed to offer an adequate characterization of politics at the Fed. And so I delved into another literature--the formal literature on regulatory policy-making--in an effort to understand the Fed. This book is the result of my efforts to use that literature to develop a new theory of the politics of monetary policy.

From an institutional perspective, the Fed is a peculiar creature. It is privately owned but publicly controlled. Private citizens own the stock of the 12 Federal Reserve Banks (Atlanta, Boston, Chicago, Cleveland, Dallas, Kansas City, Minneapolis, New York, Philadelphia, Richmond, St. Louis, and San Francisco), and the individual Federal Reserve Banks are responsible for lending to private banks and conducting the necessary clearinghouse processes for these private institutions. The "command post" of the Federal Reserve System is, however, in Washington, where the Federal Open Market Committee and the Board of Governors meet.

The Federal Open Market Committee (FOMC), like the System itself, has an unusual public/private character. The FOMC, responsible for guiding the Open Market Desk's sale and purchase of government securities (a monetary policy known as open market operations) is composed of the seven members of the Board of Governors and five of the regional reserve bank presidents. The FOMC determines the target rate for the Federal Funds interest rate (Fed Funds rate). The Fed Funds rate is the rate at which commercial banks make overnight loans to other commercial banks, and it is an important indicator of the cost and availability of short-term liquidity. The reserve bank presidents represent the private component of the FOMC. The presidents are chosen by the shareholders of the institutions that they represent, though their selection is subject to the advice and consent of the Board of Governors. The members of the Board of Governors represent the public side of the FOMC. They are appointed by the president and confirmed by the Senate. They serve 14-year terms, the longest of any federal official except the director of the General Accounting Office and federal court justices. The predominance of the public component of the FOMC is reflected in the fact that only five of the twelve reserve bank presidents have voting rights on the FOMC at any point in time. Therefore, the governors always enjoy a seven to five, public versus private, majority.

Another peculiar Fed trait, at least as far as federal agencies are concerned, is the manner in which it generates revenue for operating costs and other expenditures. The Fed does not make formal budgetary requests of Congress, and Congress does not make appropriations from the public coffers to fund Fed expenses. So how does the Fed raise the money to pay for its expenses? It owns a large portfolio of government securities on which it receives interest payments, and the Fed's securities transactions (i.e., the sale of government securities through open-market operations) also generate revenue for the System. Likewise, the Fed collects fees from private banks for certain banking services. Even in the absence of congressional appropriations, the Fed has no "budget" problems. In fact, the Fed gives billions of dollars in excess revenue to the Treasury Department every fiscal year--largesse from the bounty of its earnings. Thus, the Fed is a completely self-funding organization, a characteristic that makes it unique among federal agencies. So in important ways, the Fed is unlike any other federal agency. As Kettl notes,

The Fed thus occupies a unique place in American government: a public board supervising quasi-private reserve banks, a board free from congressional appropriations and Presidential oversight, a board composed of officials exercising Congress's monetary powers yet possessing great autonomy and broad flexibility. (1986, 4)
According to one of the Fed's most virulent opponents, Wright Patman, former chair of the House Banking Committee, "A slight acquaintance with American constitutional theory and practice demonstrates that . . . the Federal Reserve is a pretty queer duck" (Greider 1987, 49-50). In short, it is widely considered the most politically independent federal agency.

Given the singular nature of the Fed's power and character, the considerable attention it has generated, both scholarly and otherwise, is no surprise. For all practical purposes, scholars have taken an interest in the Fed and its policy-making activity since its creation. At least two books, Barron's The Federal Reserve Act: A Discussion of the Principles and Operations of the New Banking Act and Conway and Patterson's The Operation of the New Bank Act, were published about the Fed--or, more specifically, about the Federal Reserve Act--in 1914, the year after its passage. In the intervening 85 years, students of macroeconomics and monetary policy-- along with a host of journalists--have published hundreds, if not thousands, of articles and books on policy-making at the Fed.

While research on the Fed has always had an economic or financial component, it has not always included a political component. This is not to say that Fed policy-making was ever apolitical. Any time an institution has the power to influence the quantity of money within circulation--one of the Fed's most important responsibilities--then that institution can potentially affect the character and condition of the economic lives of an entire citizenry. As long as different policy choices generate outcomes that are differentially preferred and these outcomes occur in a policy area that the public considers significant, then policy choices have political implications. Although Fed policy-making has always been political, students of the Fed were not always sensitive to this fact. Because of the institution's ostensible independence, the politics of monetary policy-making were trivialized--or completely ignored--for decades.

Most early studies of monetary policy-making were founded on the assumption that the Fed was a nonpolitical, social welfare-maximizing bureaucracy. The preeminent conceptualization of Fed policy activity was the "public-interest model" (Toma 1991, 157). Explanations of monetary policy were based on dual assumptions: (1) that some socially optimal policy existed and (2) that the Fed attempted to implement that policy. Havrilesky echoes these themes by noting, "During the 1960s monetary policymakers were typically envisioned as idealistically choosing a socially consensual 'best' point on a stable, negatively-sloped Phillips Curve" (1995, 11, emphasis added). When the Fed neglected the "proper" course for monetary policy, failure was attributed to the crudeness of the policy tools and the poor quality of the information available to the Fed rather than to potentially undemocratic political machinations. In fact, "Much of macroeconomic policy analysis has been directed toward providing the Fed decision-maker with more refined tools for conducting stabilization policy" (Toma 1991, 158). So it has not always been obvious to scholars that Fed policy-making has a decidedly political dimension.

This is not to say that bankers, politicians, and Fed policymakers failed to recognize the political component of monetary policy: they recognized it from the beginning. The realization that monetary policy was intrinsically political guided the debate over the original proposal to establish the Federal Reserve System, and many economists, bankers, and politicians of the time feared a politically oriented or politically controlled Fed (Kettl 1986; Timberlake 1993; Woolley 1984). J. Lawrence Laughlin, a prominent economist, expressed a common sentiment of the time when he wrote, "We must establish some [banking] institution wholly free from politics or outside influence--as much respected for character and integrity as the Supreme Court" (quoted in Timberlake 1993, 214). Clearly, those present at the Fed's creation realized the potential for political manipulation of the value of money through the central bank's lending practices. However, it seems that most proponents of the Federal Reserve System believed they had achieved the goal, specified by Laughlin, of creating an apolitical or a politically independent institution. In retrospect, however, it is not clear that they were correct in choosing that goal or successful in its attainment. As Timberlake neatly puts it, "They did not know what they had done" (1993, 234). This thinking does, nonetheless, explain why so little attention was paid to the politics of Fed policy-making prior to the late 1960s and early 1970s. If an institution is supposedly apolitical, it hardly makes sense to spend time and energy worrying about the political character of the institution or its policies.

The early dominance of the public-interest perspective also provides an explanation for the scarcity of Fed research conducted by political scientists before 1970. Prior to this time, only a handful of the mass of articles and books on Fed policy-making were written by political scientists (see Woolley 1984, 1994 for a description of this early research). The advent of public-choice theory in the 1960s and 1970s, however, provided the impetus for a reexamination of the public-interest view of monetary policy-making (Toma 1991). The development of public-choice theory revitalized the dormant concern with the politics of monetary policy. One of the basic components of public-choice theory is the assumption that political actors are personal utility maximizers. Given that assumption, there is no obvious reason to assume that a societal goal such as macroeconomic stabilization will result from the activities of political actors. As personnel of a wealthy and powerful federal bureaucracy, Fed policymakers were, by definition, political actors. Likewise, after decades of explicitly apolitical research, students of the Fed became cognizant of the personal political benefits that would accrue to elected politicians if they could control the Fed. Munger and Roberts underscore the political significance of the Fed's responsibilities:

Because of the importance of the Fed in shaping monetary and overall economic policy, it is a powerful weapon. If political actors could gain control of it and learn how to use it effectively, there is little question that the executive, the Congress, and the other external actors could better their own lot by providing useful service to grateful constituents. (1990, 83)
Over the past 20 years, the study of the politics of monetary policy-making has become increasingly popular. Without exaggeration one can say that scholars have written hundreds of articles and books on the subject, and nearly all of this research focuses on the following general questions: First, what does the Fed do and why? And, given the answer to the first, should the design of institutions for making monetary policy be changed, and if so, how? (Alt 1991).

During the period when the public-interest model dominated thinking about the Fed, attempts to answer the first question dealt with issues of economic information (i.e., What can the Fed know about the character of the macroeconomy?) and economic understanding (i.e., What can the Fed know about the workings of the macroeconomy?). Thus, to understand what the Fed was doing and why it was doing it, one needed to determine what information was available to the Fed and what the Fed took to be the nature of the workings of the macroeconomy. Answers to the question of how to change institutions focused on changing the institutional structure of the Fed so that it might process greater amounts of information more efficiently and develop a more sophisticated and more accurate understanding of the macroeconomy. The political dimensions of Fed decisions did not figure into responses to either question.

The realization that monetary policy included a political dimension generated a reorientation in scholarly attempts to address these important questions. Answers were no longer solely a function of economic factors or issues (i.e., information and understanding): political relationships and political objectives were also viewed as important. Students of the Fed then openly considered the possibility that certain decisions were made for political rather than purely economic reasons. This possibility led to efforts to understand the political dimension of monetary policy and to address questions concerning the political objectives of the Fed and of those actors who might influence Fed policy-making: elected officials such as the president and members of Congress.

The realization that elected officials might influence or manipulate the Fed led to a consideration of the proper role for the president and legislators. The Fed's original architects viewed a significant role for elected officials in monetary policy-making in a very negative light. Not surprisingly, much of the debate concerning the structure of the Fed focused on optimal means of insulating the Fed from political manipulation (see Woolley 1984; Timberlake 1993). But this discussion occurred prior to the Keynesian revolution, which suggested that government--and, implicitly, elected officials--should actively manage the national economy. Thus, cognizance of monetary policy-making's political dimension did not necessarily imply that elected officials could not have a positive impact on the character of Fed policy.

Of course, to determine the roles elected officials should play in monetary policy-making, one must first understand the roles that they do play. How, for example, would monetary policy change if a tight-money president replaced an expansion-minded chief executive? Would the specific impact of this regime change depend on the distribution of policy preferences within Congress? How would a change in party control of the House (or Senate) influence policy? Once these questions are answered, it is possible to evaluate the extent to which institutional changes are likely to aid or hinder the achievement of the policy goals deemed most preferable. Basically, without knowing elected officials' actual effects on monetary policy, it is impossible to draw reasonable conclusions about their proper role in the policy-making process. Effective policy reform requires a sophisticated understanding of the current nature of policy-making. One must understand the inner workings of the policy arena before prescribing change.

The juxtaposition of the immense scope of the Fed's power and influence and the undemocratic character of its formal institutional structure piqued my interest in monetary policy. I began to ask the same questions students of the Fed have been asking for at least a couple of decades: Why is the Fed's institutional structure the way it is? To what extent is the Fed independent of political influence in the guise of presidential or congressional manipulation? If the Fed is not independent of the influence of elected officials, how do these officials implement or exercise their influence or manipulative powers? If the Fed is half as powerful as many journalistic and scholarly accounts contend, then attempting to understand its place (both actual and proper) in the American polity is an important endeavor, because doing so deals with the core issue of a people's capacity to govern themselves effectively.

Students of monetary policy-making have attempted to answer these questions from a variety of different viewpoints. Woolley (1994) argues that the study of the Fed may be divided into at least three schools of thought: the central bank independence (CBI) perspective, the pressure-groups perspective, and the principal-agent perspective. Proponents of the CBI perspective focus on the formal institutional relationship between central banks and their political environments. Politicians are assumed to want inflationary monetary policies; to the extent that central banks--who are assumed to prefer monetary policies that are consistent with price stability--are protected from the pressures and manipulation of elected officials, the banks will act to preserve price stability. Comparative analyses of this type suggest that the Fed is one of the most independent central banks and that political influence plays a relatively minor role in the determination of U.S. monetary policy.

Supporters of the pressure-groups perspective take an opposite tack, suggesting that formal institutions are less important than the informal relationships between policymakers and special interests. Studies within the pressure-group camp focus on the relationship between changes in the policy preferences of important actors in the Fed's political environment (i.e., the president and Congress) and the corresponding changes in monetary policy. Implicitly, the pressure-group perspective is based on the assumption that constellations of political groups make policy. Institutional relationships, while somewhat interesting, are not the core determinant of monetary policy activity.


Excerpted from Congress, the President, and the Federal Reserve: the Politics of American Monetary Policy-Making by Irwin L. Morris Copyright © 2000 by Irwin L. Morris. Excerpted by permission.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.

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