The American Enterprise Institute’s John Makin—“Dr. Doom,” to his numerous friends—has a piece on the Federal Reserve Board’s recently instigated “QE3” program that is bone-chilling even to regular Makin followers (including yours truly). In essence, QE3 is a “whatever it takes” program to goose the economy with easy money. It may work if the Fed can stay ahead of inflation expectations—that is, if bondholders are stupid and labor markets sticky. The sooner people catch on, the faster the Fed will have to double down. Eventually, it will have to close the spigot—manageable, perhaps, if the economy at that time shows robust growth; disastrous, if it is still in the doldrums. The Fed is making this fantastic gamble because (1) nothing else seems sufficient to revive sluggish growth and employment and (2) a much-noted article by an economist says that this might work.
I have no clue whether QE3 is a good or bad idea. I am quite confident, however, that the Fed’s aggressive course should and in due course will prompt political agitation over its institutional role and design. Alas, merely asking the question tends to bring out the lunatics on all sides (“JFK was killed because he threatened the Fed!” “Attack on the New Deal, Constitution in Exile!”) Perhaps, though, there is still time for serious deliberation and debate.
Our fate hangs on the Fed; and yet, it is an independent institution, immunized from direct political pressures. In a democracy, operating under a Constitution that makes no explicit provision for a central bank and in many ways resists the creation of fourth or fifth branches of government, an independent Fed is an oddity. For what it’s worth, the Fed’s founders acknowledged the point: initially, the Secretary of the Treasury served as the institution’s ex officio chairman. That arrangement was changed in the 1930s, after the Supreme Court had cleared the way for “independent” agencies.
There are two (and only two) justifications for the arrangement. The first is expertise—not so much the ability to collect it (which can also be done by Congress or the executive), but the ability to act on it without undue political influence. This is the traditional New Deal argument for independent agencies. As it happens I’m not terribly impressed by it. At a bare minimum, though, it presupposes that the agency deals with something that you can actually be expert about. It also presupposes a known and agreed-upon goal and a set of rules and incentives that keeps the agency oriented toward that goal. Otherwise, we’re just deploying technical wizardry for bureaucratically generated objectives. That does not sound like a good idea.
The second justification for Fed independence is the political system’s inability to precommit to a stable currency. Leave the printing press in the politicians’ hands: they’ll debase the currency in a heartbeat. We can’t allow that.
The precommitment argument is better than the expertise argument, but it’s not entirely free from doubt. After all, it would also be a good idea if we could precommit to a stable federal tax system. (The fact that no one knows what taxes will be five months from know, plus the fact that whatever Congress may then decide will also last for at most a year, hangs like a wet blanket over the economy.) Arguably, however, there is a constitutional warrant for committing monetary stability (but not fiscal or other questions) to an independent institution.
There is no shred of doubt that the Founders wrote the Constitution in the expectation of, and for the purpose of ensuring, a hard currency. Individual clauses (for example, the prohibition against the state emission of bills of credit) illustrate the point. More importantly, so does the entire constitutional structure. The structure is entirely compatible high and low taxes; with energy subsidies and without; with a nightwatchman or a nanny state. Not so with the hard money constraint: take that away, and the Constitution—starting with the virtually unlimited powers of Congress to tax and spend—becomes a pact with the devil. So viewed, an independent Fed is a necessary and proper means for the responsible exercise of a federal power—the power to coin money and to regulate the value thereof (and no, that clause does not mandate a gold or other metallic standard).
This is the general shape of an argument for an independent Fed, not the argument itself. (For example, if my originalist friend were to insist that the argument is Humphrey’s Executor redux, I’d beg to differ but readily acknowledge the need for explanation and elaboration.) For present purposes, though, the point is this: there is no constitutional warrant for an independent Fed that acts as the economy’s master puppeteer; issues puts on the stock market; expropriates fixed-income recipients so that Congress can continue to borrow on the cheap; or targets the unemployment rate.
John Makin envisions a process by which the Fed might unwillingly return to what I believe to be its constitutional limits. If its gamble fails to fool the markets, he writes,
the Fed would be forced to avoid sharply higher inflation by engaging in a long and costly process of tightening monetary policy to reanchor inflation expectations at a low level. That process could involve returning the Fed to a single mandate—price stability—that explicitly precludes it from employing monetary policy to affect real variables like growth and employment. Ironically, the application of QE3+, with its aim to use monetary policy to improve labor market conditions, may ultimately result in a prohibition, via a single mandate for price stability, of a link between monetary policy and labor market conditions.
From an institutional perspective, that wouldn’t be the worst outcome. It would be better still, though, if we could get to a monetary stability system without a crash-and-burn exercise. If we want to stage gambles, plenty of institutions answer to the task. The Fed’s point is to prevent them. And that point, for what little it may be worth, is constitutional.