All bureaucracies try to grow their power. Few have been as successful as the U.S. Federal Reserve.
Since the 2008 financial crisis, America’s central bank has steadily grown in authority and influence. That’s good for monetary policymakers and bad for everyone else. There’s a case to be made the Federal Reserve is eclipsing even Congress in power. During the early days of the coronavirus pandemic, Congress explicitly called on the central bank to expand its emergency lending activities. This created a troubling precedent: When the chips are down, the people’s representatives have no problem passing the buck to unelected technocrats. Isn’t this a good thing? Shouldn’t we be happy that an army of economics gurus is in the driver’s seat instead of prime-time partisans?
No, unfortunately. We’ve just traded one set of woes for another.
The Federal Reserve’s immense power has two key sources.
First, during the 2008 financial crisis, the bank started paying private banks interest on excess reserves, with the goal of keeping a lid on inflation. This is how the Federal Reserve has controlled price increases over the last decade. Prices go up when banks use newly created money to finance asset portfolios. But if banks get paid not to lend — in essence, if the Fed borrows back all that newly created money — there’s no upward pressure on prices. Paying interest on reserves severs the link between the size of the Federal Reserve’s balance sheet and inflation. Previously, if the Fed was too loose with money, it would have to correct its course. But without the inflation constraint, its balance sheet “is no longer tied to monetary policy,” according to former Philadelphia Federal Reserve bank President Charles Plosser. The central bank can create money and buy assets, and hence allocate purchasing power, with few repercussions.
The second change is the weakening of the Federal Reserve’s emergency lending rules. Previously, the bank was authorized to make loans only to maintain the health of the financial system. But this power grew during the pandemic. Now, the Federal Reserve can lend to organizations that have nothing to do with financial stability. Large corporations, small businesses, state and municipal governments — the bank extended credit to all of them. Although these loans were only a small percentage of the central bank’s balance sheet, the size of the programs isn’t what matters. It’s precedent. This is a power easily abused. These changes are bad for economic stability and self-governance. Because it can pick winners and losers, the stakes of influencing the Federal Reserve are much higher. Special interest groups will try to steer the bank’s policy.
We risk the Federal Reserve allocating credit for political reasons rather than economic ones. Meanwhile, its mandate of full employment and price stability will fall by the wayside. That’s great if your day job is in high finance. It’s not so great if it isn’t.
There’s also a basic question of political authority. Congress has delegated too much of its authority to agencies and organizations that the public has a harder time monitoring. Congress is supposed to conduct fiscal policy as the deliberative body hashing out who gets what. It’s a basic failure of self-governance to insulate these decisions from the democratic process.
Top line: The bank used the two great economic crises of the 21st century as an excuse to expand its power. This won’t make economic policy more effective, just less accountable. The public can and should try to rein in our central bank. We can’t afford to wait until the next crisis to get national economic policy back on track.
Alexander William Salter is an associate professor of economics in the Rawls College of Business at Texas Tech University, the Comparative Economics Research Fellow at TTU’s Free Market Institute, and a Young Voices senior contributor. Follow him on Twitter @alexwsalter.
