I’m very late coming to the scrum over Gov. Rick Perry’s very gamey comments about Fed chairman Ben Bernanke more than a week ago, which attracted fierce criticism from just about the entire political spectrum. But with Bernanke back above the fold of today’s news with his Jackson Hole comments that sent the market gyrating wildly once again (which may be the new normal?), it seems propitious to revisit one aspect of the issue that Perry raised.
One does not need to be a Ron Paul-style Fed-basher, an inflation hawk, a gold bug, or a deflation paranoiac to puzzle over the status and actions of the Federal Reserve. It is almost certainly a constitutionally permissible institution, but its relative political independence is nonetheless problematic from several points of view. Today isn’t the first time that the independence of the Fed has been controversial; both liberals and conservatives groused about the Fed and threatened congressional action to bring it to heel back in the 1980s, especially early in the 1980s when the Fed imposed brutally high interest rates to break the back of Jimmy Carter’s inflation. Maryland’s long-time senator Paul Sarbanes made putting the Fed under more direct political control his main mission in life. Some conservatives and many supply-siders thought Paul Volcker was killing Reagan’s supply-side program by tightening monetary growth too much in the recession of 1981-1982, and they have a strong case.
The Fed’s “independence” does not exist in a complete political vacuum, however. Volcker recognized this, commenting candidly back then that “No central bank can—or should, in my judgment—conduct policies for long that are out of keeping with basic, continuing objectives of the political system.” But there are different ways of exerting effective political pressure on the Fed besides a barbed public broadside like Perry’s. There is a large question of prudential judgment here, and how any candidate—or newly-elected president, if we (hopefully) have one 18 months from now—handles the issue is crucial.
When Reagan took office in 1981, a lot of people, including some of Reagan’s advisers and top political backers, thought Reagan should force out Volcker, and get his own man at the Fed. Here’s how I pick up the story in The Age of Reagan:
Sure enough, in the opening weeks of his administration Reagan had said that “We fully recognize the independence of the Federal Reserve System, and will do nothing to interfere with or undermine that independence.” Reagan understood this as a matter of principle, but he had also roughed up Volcker in his typically understated fashion.
Reagan had his first meeting with Volcker over lunch on his third day in the Oval Office. Reagan opened the lunch with a question that must have nearly knocked Volcker out of his chair: Why do we need a Federal Reserve anyway? Martin Anderson, who had prepared a memorandum for Reagan briefing him for the meeting, recalls Reagan’s words as follows: “I was wondering if you could help me with a question that’s often put to me. I’ve had several letters from people who raise the question of why we need a Federal Reserve at all. They seem to feel that it is the Fed that causes much of our monetary problems and that we would be better off if we abolished it. Why do we need the Federal Reserve?” Had Volcker been chewing on one of his trademark cigars, Anderson thought, he would have swallowed it.
Reagan was invoking here the idea of “free banking,” which he probably learned about from his reading of conservative and libertarian periodicals such as The Freeman. “Free banking” is essentially the system of privately-issued competitive currencies in a system without a central bank. Was Reagan just trying to make small talk or expressing curiosity about Volcker’s opinion, or was he sending a subtle signal that he could make a world of trouble for the Fed if it didn’t mesh with Reagan’s policies? Reagan had already expressed some sympathy for the gold standard, which would severely circumscribe the role of the Fed if adopted. Now Reagan was hinting that he could consider going far beyond this. To orthodox Keynesian economists, if tax cuts were “voodoo economics” and the gold standard a medieval superstition, the idea of “free banking” ranked somewhere below leechcraft.
Volcker needn’t have worried about such a radical prospect, but with Washington rife with rumors that Volcker had little regard for Reaganomics, Reagan had subtly reinforced that Volcker needed to restrain his public remarks. Between the election and inauguration, Volcker had made several public comments that suggested skepticism of Reagan’s supply-side prescriptions. “Let us not be beguiled into thinking there are quick and painless solutions,” he told a New York audience, and that “the likelihood of a squeeze is apparent.” After Reagan took office, he became more circumspect.
Point taken, obviously. Those Republicans who say Reagan is their model (are there any who don’t?) might want to study this kind of Reaganeque method more closely.