Bernanke Deputy Kohn: Political Pressure Is Nothing New, But Trump’s Recent Actions Unique In History

“The heyday of central bank independence now lies behind us”, Pimco’s Joachim Fels wrote, in a July client note that served as a kind of fatalistic assessment of a world in which monetary policy is under siege from enterprising politicians.

Although Donald Trump and Turkish President Recep Tayyip Erdogan (who apparently purged more CBT personnel on Thursday after firing Murat Cetinkaya last month) get all the press when it comes to encroaching on their respective central banks, there are plenty of other examples. In India, for instance, the RBI has seen its autonomy whittled away.

Beyond overt instances of political interference in monetary policymaking, there’s a strong argument to be made that in the future, central banks will be politicized as a matter of course given the necessity of marrying monetary and fiscal policy in the interest of delivering a mix that works to engineer real economic outcomes as opposed to acting as a bubble machine for financial assets. That goes double at a time when monetary policy may have reached the end of the road when it comes to what can be tried.

Read more: ‘Like It Or Not, The Heyday Of Central Bank Independence Is Behind Us’, Pimco Says

Indeed, the nexus of monetary and fiscal policy is part and parcel of the modern monetary theory dream, as outlined explicitly by MMT’s foremost champion, Stephanie Kelton. Greater coordination between fiscal and monetary authorities is almost certainly the wave of the future, she told Bloomberg last month, in an interview. She went on to say that central banks won’t admit to having lost their independence, but the bottom line is that you’re going to see central banks responding in more accommodative, coordinating ways.

All of the above serves as the backdrop for the latest edition of Goldman’s Top Of Mind” series, which finds the bank asking whether and to what extent market participants should be worried.

“The US Federal Reserve’s sharp pivot toward easing amid substantial White House pressure has raised concerns about central bank independence, as have developments in other advanced and emerging market economies alike”, the bank’s Allison Nathan writes. Here’s a handy infographic Goldman utilizes to set the stage:

(Goldman)

As a reminder, the bank’s “Top Of Mind” notes are expansive takes on whatever the market topic du jour happens to be. They combine interviews with Goldman’s own employees and also with outside sources in an effort to provide a balanced and comprehensive assessment on whatever seems to be the most important question on market participants’ minds (hence “Top of Mind”). The above-mentioned Allison Nathan conducts the interviews and collates the charts and analysis.

Below, find selected excerpts from the bank’s interview with Donald Kohn, former Fed Vice Chair and current Robert V. Roosa Chair in International Economics and senior fellow at the Brookings Institution.

Via Goldman (abridged from a much longer interview)

Allison Nathan: Why has monetary policy come under attack in the recent period? Is this all about President Trump, or are there other factors at work?

Donald Kohn: It’s not unusual for presidents, particularly those facing re-election, to want easier monetary policy. President Nixon pressured Fed Chair Arthur Burns. In Paul Volcker’s recent memoir, he talks about an incident in which President Reagan’s then chief of staff, James Baker, invited him to the White House in 1984 and told him not to raise rates again. And the elder President Bush—along with a bi-partisan group of senators—constantly beat on Alan Greenspan for lower rates in a very intense and public way. So, political pressure is not uncommon historically. But, at least in my view, President Trump’s actions of late have been more intense, more constant and more denigrating towards the people making monetary policy decisions than in the past.

That said, there is little doubt that the perception of the Federal Reserve took a hit during the GFC. People look to the Fed to preserve financial stability, and therefore blamed the Fed, at least in part, for the severity of crisis. There also seemed to be a narrative that the crisis response favored banks and lenders rather than the people, and that the unconventional policies favored the rich over the poor. I don’t think that’s true. But it has undoubtedly been a long, hard recovery. Taken together, I think the series of events during the crisis—mixed with subpar performance of the US economy in the wake of it—have reduced confidence in the Fed, and perhaps left it marginally more vulnerable to attack.

Allison Nathan: So how concerned should we be about the Fed’s independence today?

Donald Kohn: I think concern is warranted. The president’s criticism has not changed the legal framework supporting Fed independence; there is still budgetary independence, fixed terms, and independently operating reserve banks. But I do think the legal framework rests on public support. And I am somewhat worried that constant criticism could over time undermine public support for Fed independence. I also think that the criticisms have raised questions about whether the Fed’s motivation for its shifts in communication and policy comes from political pressure, even if the Fed’s actions are fully justified in economic terms, which I think is the case today. So overall, I think the open expression of pressure that we’re seeing today is just not helpful and tends to undermine the credibility of the central bank. If the president has valid concerns, he and we would be better served if he raised them behind closed doors.

[…]

Allison Nathan: With the Fed—and other major central banks around the world—already shifting back into easing mode so close to (or beyond) the Zero Lower Bound (ZLB), should there be greater coordination between monetary and fiscal policy, and can we achieve that without eroding central bank independence?

Donald Kohn: At the ZLB, unconventional policies can have some effect, but probably not as much as traditional monetary policy does when we’re not at the ZLB. So fiscal policy may be the more effective tool. But I don’t think formal coordination is necessary. During the GFC, the Fed took interest rates down to essentially zero, and vowed to keep rates there for a long time while also purchasing Treasury securities. Together, that facilitated the fiscal expansion that helped the US begin to recover from the recession. So a formal coordination mechanism wasn’t necessary; when the fiscal authorities and the monetary authorities have the same aim— recovery from deep recession—their policies will naturally tend to complement each other. That said, I think fiscal authorities generally need to be more active when monetary authorities are stuck at or close to the ZLB.

[…]

Allison Nathan: What actions—if any—could the Fed take to protect its independence that it’s not taking right now?

Donald Kohn: The Fed is absolutely doing the right things at this point, but it must continue to be proactive. First, and most importantly, it must make sure that any policy action is justified by the Fed’s objectives, and is based on sound economic reasoning to avoid looking like it’s giving into political pressure. Second, it must continue building relations with the legislature and with the people. That means explaining the importance of independence to members of Congress, and talking in plain English to ordinary people about what the Fed is doing and why. I think the more the bank builds understanding both on Capitol Hill and around the country about what it’s doing, the easier it will be to protect its independence.


 

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