Trump’s Fed Comments Might Seem Scary, But Monetary Policy Is Political

There’s no reason to think that Trump is some kind of monetary policy guru, but maybe having the U.S. president directly involved in monetary policy isn’t as crazy as it seems. Perhaps it would help voters hold elected officials more accountable for the Fed’s policy decisions.

I know that sounds sacrilegious—the Fed’s independence is supposedly vital. It allows the Fed to ignore politics and make the best economic policy decisions. That’s what everyone says, and it sounds great. But the Fed’s independence is largely a myth.

A great deal of research supports that it’s a myth, as does anecdotal evidence and contemporaneous historical accounts. For instance, in his memoir The Courage to Act, former Fed chair Ben Bernanke wrote “If I had learned one thing in Washington, it was that no economic program can succeed, no matter how impeccable the arguments supporting it, if it is not politically feasible.”

Nonetheless, the conventional story persists to this day.

Here’s the quick version of that story. When Congress created the Fed in 1913, the Fed didn’t have the independence it needed because the Treasury Secretary and the Comptroller were members of the Fed Board. Congress tried to fix that problem in 1935, but even after they excised the Treasury from the Fed, the Fed and Treasury still collaborated to help finance the nation’s war debt.

Supposedly, this cooperation lasted until 1951, when President Truman pressured Fed chairman Thomas McCabe to resign, replacing him with William McChesney Martin. At the time, Martin was the assistant secretary of the Treasury, and everyone was nervous that he would be Truman’s stooge at the Fed.

As it turned out, though, Martin stood up to Truman and won the Fed’s reputation for doing the right thing, which was keeping monetary policy tight to fight inflation even though it was unpopular. Martin, who served as Fed chair until 1970, is famous for describing the Fed as “the chaperone who has ordered the punch bowl removed just when the party was really warming up.”

Then, supposedly, Martin’s successor regressed. Aurthur Burns famously lowered rates to help President Richard Nixon win reelection, igniting inflation in the 1970s. But then Paul Volcker, chairman from 1979 to 1987, stuck to tight monetary policy in the face of a recession, thus vanquishing inflation and restoring the Fed’s independence. Ever since, the Fed has ignored politics and made tough calls, thus maintaining its independence and protecting its reputation.

That’s how the story goes, and that’s why people are freaking out about Trump’s comments. But that story is an epic myth.

To begin with, the record shows Martin believed the Fed was obligated to support the Treasury’s efforts to sell debt. Regardless, president Eisenhower pressured Martin to ease monetary policy during the 1953–1954 recession, and Martin complied rather than resign.

Presidents Kennedy and Johnson both pressured Martin in the same way, and Martin caved in. To be fair, when Johnson pressured Martin, Congress was openly hostile to tighter money, and actively threatened to limit the Fed’s authority by amending the Federal Reserve Act.

The exploits of Arthur Burns and president Nixon are well known, but few people discuss what happened during Gerald Ford’s presidency. In 1974, for instance, Congressman Wright Patman—the namesake of the House Financial Services Committee hearing room—threatened the Fed with Government Accountability Office audits, making it subject to congressional appropriations, and requiring district bank presidents to be confirmed by the Senate. Congress wanted expansionary monetary policy and Arthur Burns caved. (Burns also met with President Ford “more often and over a broader range of issues than had any other chairman in the Fed’s history.”)

And while Paul Volcker initially had President Reagan’s support for tighter monetary policy to kill inflation, the 1982 recession changed things. Reagan soon reminded Volcker that the Federal Reserve Act is always subject to change, and Reagan’s chief of staff, James Baker, threatened to support Congress’s efforts to rein in the Fed if it didn’t ease monetary policy. (Senator Edward Kennedy (D‑MA) was threatening to make the Fed part of Treasury, and Senator Robert Byrd (D‑WV) wanted to give Congress the authority to force the Fed to lower rates.) Volcker caved.

None of this really should be surprising, because inflation, employment, and business cycles will always be hot button political issues. Besides, the Fed is a creature of Congress and the fiscal agent for the U.S. Treasury. It’s a central bank, and one of the main functions of a central bank is to enable the government to borrow money. Good luck avoiding politics.

If people want to hold elected officials accountable for monetary policy, the current arrangement leaves a great deal to be desired. Few members of Congress have any idea what the Fed is doing, and the Fed has enormous discretion on how it conducts policy.

At the very least, making the Fed part of the Treasury or placing it under the direct control of Congress would prevent politicians from hiding behind the Fed’s independence. Preferably, Congress would also require the Fed to follow a policy rule and place restrictions on how much Treasury debt it can purchase.

Without these kinds of changes, Americans will continue to witness the political finger pointing that occurred after inflation spiked in the wake of the COVID-19 spending spree.