Yves here. In a discussion of five recent books on the Federal Reserve, James Galbraith covers a very wide terrain, which results in this essay consisting more of intriguing vignettes and observations than a big thesis. The first portion strongly features Galbraith giving personal accounts from the time he served as a staff economist to the House Banking Committee and later the Joint Economics Committee, with detailed accounts of how the current Fed chair, Arthur Burns, eventually got cornered in persistent efforts to increase transparency, but how other Congressional mandates wound up not amounting to much.
I would quibble on a few points. It’s not clear how much of the Fed could ever be well-overseen by Congress; Galbraith acknowledges in passing that the regional Feds, including the powerful New York Fed, do not have any direct accountability. He does confirm something I’ve mentioned in comments, that it was Paul Volcker who first sought and implemented a strong dollar policy.
Later in his piece, Galbraith points out that the Fed now has comparatively little power over interest and employment rates. He does not describe how a big reason is the diminished position of the Fed and banks relative to financial activity. In Volcker’s era, the Fed represented 20% of total US banking system assets. Right before the crisis, banks accounted for only 15% of total commercial and industrial loans. So the Fed’s ability to influence banks via regulation as well as interest rates has fallen considerably.
By James K. Galbraith, who holds the Lloyd M. Bentsen, Jr. Chair in Government/Business Relations at the Lyndon B. Johnson School of Public Affairs, The University of Texas at Austin. His new book, with Jing Chen, is Entropy Economics: The Living Basis of Value and Production, just published by the University of Chicago Press. Originally published at the Institute for New Economic Thinking website
Books discussed in this essay:
Sarah Binder and Mark Spindel, The Myth of Independence: How Congress Governs the Federal Reserve. Princeton: Princeton University Press, 2017.
Jeanna Smialek, Limitless: The Federal Reserve Takes on a New Age of Crisis. New York: Penguin Random House, 2023.
Robert Hockett, Spread the Fed: Distributed Central Banking for Productive-Republican Finance. Palgrave MacMillan Economics, 2024.
Jane D’Arista, One Among So Many: A Memoir. Self-published, 2024.
Leah Downey, Our Money: Monetary Policy as if Democracy Matters. Princeton, Princeton University Press, 2025.
Introduction
Each of the five books discussed in this essay deals with what Jeanna Smialek calls the “modern era” of American central banking, wherein the Federal Reserve became the country’s preeminent macroeconomic policy institution, charged by law with working to maintain “maximum employment but also slow and stable inflation” as Smialek puts it. More precisely, in the language of the 1978 Humphrey-Hawkins Act: “full employment… balanced growth… and reasonable price stability.”
Only one of the five is by a participant in the forging of the Fed’s modern era, and that is a brief treatment in a personal memoir by Jane D’Arista. D’Arista describes the long campaign for central bank accountability – “Patman’s chess game,” his staff called it – waged by Rep. Wright Patman (D-TX), chair of the House Banking and Currency Committee, and his successor from 1975 to 1980, Rep. Henry Reuss (D-WI). Reuss capitalized on reformist sentiment following the 1974 Watergate election to advance House Concurrent Resolution 133, requiring quarterly appearances by the Chair of the Federal Reserve Board – Arthur Burns at the time – before the Banking Committees of the House and Senate, and specifying (more-or-less) precise questions for that testimony to address. It was from the practice of these hearings, refined over several years, that the statutory language of section 108 of the Humphrey-Hawkins Act, dealing with monetary policy, emerged.
In their important 2017 book, Sarah Binder and Mark Spindel give the best account I’ve seen of the history of congressional oversight of the Federal Reserve. They make the indisputable point that under the Constitution, Congress carries the ultimate burden of specifying monetary policy and thus authority over the central bank. This legal reality stems from the fact that the Federal Reserve is a creation (and a “creature”) of Congress, a statutory body as the executive and judiciary are not. The design of the Federal Reserve, with its twelve regional banks spread across the country according to the developmental patterns of the Railroad Age, was a congressional confection. It was intended, as Robert Hockett shows in his massive inquiry into original purposes, as a bulwark of decentralized industrial and commercial finance for economic development and common prosperity. Thus the Federal Reserve has been “under Congress” from the beginning, and Congress has shaped and reshaped the Federal Reserve periodically since 1913. The Fed depends on Congress in a way that (say) the European Central Bank does not depend on the European Parliament.
But this reality elides a parallel reality, which is that the Federal Reserve’s leadership has only sometimes acknowledged the constitutional and legal position. Before 1975 Burns and his predecessors largely disdained Congress (and enjoyed important congressional support in so doing). After the early 1980s, the Fed’s leadership under Alan Greenspan turned “congressional oversight” to their advantage, making the regular hearings into a stage set for monetary dicta. As Leah Downey relates, in the 2000s, under Ben Bernanke, the Fed set out to rewrite the congressional mandate by elastic use of language, to suit the macro-theoretic fashions of that moment. Congressional oversight requires overseers with confidence and competence, and these are historically exceptional. Hence the Patman-Reuss era takes on a special significance, all the more so in view of the fact that the institutional framework they put in place has now endured for fifty years.
Before H.Con.Res. 133 the Federal Reserve had few fixed duties to Congress. It fell only loosely under the Employment Act of 1945, and had been freed of direct obligation to support the price of Treasury bonds by the “Accord” of 1951, which had (as Binder and Spindel report) the strong back-channel backing of the Senate’s then-leading (and perhaps only) economist, Senator Paul Douglas (D-IL), chair of the Joint Economic Committee and a man whose name still haunts students via the infamous “Cobb-Douglas production function.” Practically the only bearing of Congress on Fed operations was through the appointment power, restricted to the Senate and applying only to the seven governors of the Federal Reserve Board, not to the twelve Presidents of the regional Fed banks. Once confirmed, Fed officers needed have little further contact with Congress unless they wanted new legislation (or to oppose some congressional initiative), and apart from that, the House had no leverage to speak of.[1] For this reason, Patman had resolutely pursued his goals of making the Fed subject to audit and placing it under the budget, but without success.[2]H.Con. Res.133, and its inauguration of regular hearings to evaluate specified macro- and monetary objectives, was therefore a substantial step in the right direction.
Monetary Policy and Economic Theory from 1945 to 1975
Although accounts of this period tend to emphasize the institutional and political developments, along with intermittent struggles over power and policy, crucial context can only come from a review of intellectual and theoretical perspectives as they evolved at that time. By 1975, the New Deal of Franklin Roosevelt had been over for thirty-five years, and the mobilization that had produced victory in World War II for thirty. Veterans of that period were still in senior roles on Capitol Hill, and a few policy warriors of the 1940s, notably Leon Keyserling and Bertram Gross, were still active in the corridors. These people tended to see government and economy as an integrated whole, with an expansive role for public purpose specified by legislation and executed by public administration. They saw business and labor (ideally, not always in practice) as partners in a common national project, and finance – the big bankers – as competitors with democratic institutions for power. By 1975 their worldview was a fading force, overtaken in academic circles by postwar economic theory. It would enjoy a last hurrah with the drafting of H.R. 50, the Hawkins-Reuss bill, spur and predecessor of the Humphrey-Hawkins Act.
Postwar academic economics in America had been dominated by a school variously described as neo-Keynesian, the neoclassical synthesis, or simply, the New Economics. Based mainly at MIT but with tentacles throughout the leading departments, and a lock on the textbook market, this school advanced what Reuss called a “needle-valve” view of economic management, centered on fiscal and monetary measures, operating on a market system according to certain statistical relationships which were supposed to have structural significance. Of these, the two most important were Okun’s Law, relating the growth rate of GDP to the rate of unemployment, and the Phillips Curve, relating unemployment to inflation. Other regulatory interventions – antitrust, labor, and environmental standards – were admitted, but considered secondary. The key to the setup lay in the assumption that the key “laws” could bear the weight of policy interventions, with unmolested markets adjusting to deliver predictable, efficient (and presumably, desired) outcomes. The economy could therefore be modeled as a system of (linear) equations on the newly developed computers of the time. This transformed the “macro-economists” in government into the pilots of a vast aeronautical machine, tasked with keeping it aloft, steady, and above all from stalling, diving, or crashing. The problem with this contraption, by the mid-1970s, was that it was clearly not airworthy. The question therefore was what would come next.
In the face of the recession of 1970, the collapse of Bretton Woods in 1971, the first oil shock of 1973, and the deep recession of 1974, the leading academic challenge to the neo-Keynesians came from Milton Friedman and his Chicago acolytes, who sought to fix the jury-rigged structures of the neo-Keynesians by the simple device of (almost) abolishing them altogether. The problem was not the aircraft, its control system, its maintenance or its fuel. The problem was pilot error. The solution was not better pilots but to get rid of pilots – rules over discretion. Set an autopilot – a monetary control rule – Friedman argued, and the machine would fly level and indefinitely on its own. The implicit underlying metaphor was no longer a plane (which requires fuel and maintenance) but, say, a Zeppelin or perhaps a simple helium balloon. Other rules – balanced budgets, deregulation, Free Trade – might be concocted for other policy areas, but for central banking, monetary control was it. Friedman had stipulated an annual money growth rate between two and six percent, to allow for growth and minor inflation. His leading supporter in the Senate, William Proxmire (D-WI) had tasked the Federal Reserve with reporting by letter twice a year (if I recall correctly) on whether money growth (M1 for aficionados) had fallen within that range. It rarely did.[3]
House Concurrent Resolution 133 and the Hearings on the Conduct of Monetary Policy
My own direct engagement with these issues began with a message taped to the door of my rooms at Peas Hill Hostel, graduate housing overlooking the market square and belonging to Kings College Cambridge, on a cold evening in late January or early February, 1975. It instructed me to call Congressman Reuss collect by close of business Washington time. There was a pay phone in the basement. I had worked for Reuss the previous summer, on a subcommittee dealing with international economics of the Joint Economic Committee, leaving for Cambridge on a Marshall Scholarship after botching a proposed amendment to the Export-Import Bank bill that would have stalled preferential financing for sales of the then-new Boeing 747, a monopoly product that (it seemed to me, aged 22) should have been bankable on commercial terms. Boeing and its many subcontractors were not amused and Reuss, having prevailed in markup, was obliged the next day to withdraw his amendment. I remember the guard at the Rayburn House Office Building, seeing my face as I walked to the committee chambers, saying, “It can’t be that bad.” I did not expect to hear from Reuss, who had just been elected to succeed Patman as Chair, but I returned the call, congratulated him, and was astonished to hear him invite me to be “chief economist” for the Banking Committee. I agreed a few days later to return in June but with no special title. “Staff economist” would do.
My colleagues on arrival that June included the Patman holdovers – among them D’Arista – a lawyer from the McGovern campaign, Bill Dixon, who later advised Gary Hart, a former associate research director at the Fed, Jim Pierce, his lawyer wife Mary Ann Graves, and an energetic, dogmatic, hard-core Chicago monetarist, Bob Weintraub, soon joined by another equally hard-core, Bob Auerbach. Both were Friedman students, both remained my friends for life – in Weintraub’s case until his early death in the 1980s, in Auerbach’s through a migration that led to an office next to mine at the LBJ School until his retirement in 2016 and death (at 88) early the next year. As a Cambridge (UK) Keynesian, however greenhorn, I was the odd person out in the trio. It was a curious menage, but good-humored and tremendous fun. The staff director, Paul Nelson, would call us to go see the Chairman: “Better hurry, Bob Auerbach is already talking!”
Our common ground, from the left-Keynesian that I was, to the mainstream Pierce and the two Friedman disciples, lay in a determination to crack the secrecy and obfuscation that shrouded Federal Reserve policy in mystery – a mystery, we suspected, intended to obscure the influence of the White House (notoriously, Nixon’s over Burns in 1972) and that of the major banks. Neither was likely to serve the public interest, which was for Congress – that is to say, ourselves – to define. We did not agree on how precisely to define it, but so much the better, that meant that we could ally across multiple perspectives and unite Members with strongly varying views. Transparency and clarity of objectives (and associated forecasts) could be common goals. The quarterly hearings specified under H.Con.Res. 133 created a venue for the pursuit of “government in the sunshine.” Monetary control objectives provided a format that could be specified in law without leaving the impression that Congress sought to dictate interest rate policy on a day-to-day basis.
The day before our first hearing, Pierce, Graves, Weintraub and I briefed the Democratic Members.[4] Our strategy was simple: to ask Chairman Burns, respectfully until he answered, to release the Board’s internal economic forecasts for growth, employment and unemployment, and inflation, consistent with the money growth projections he was already obliged to supply. Burns resisted until early afternoon, as Members took turns asking the question. Finally in response to one of the junior Members – it may have been Jim Blanchard (D-MI), a freshman and later Governor of Michigan – he relented to the extent of giving his “personal forecast.” At that point we asked whether his personal forecast was consistent with that of the staff and Board – and we had him. At future hearings, the question could be phrased as a request for “a personal view, consistent with the forecasts of the staff and Board” – or words to that effect. Soon enough the forecasts themselves were made public.
Binder and Spindel give an accurate account of the Fed’s early efforts to empty the money growth targets of any meaning – actually they never had much meaning – by rolling deviations into the base for projections made the next quarter. In this way the projections could be kept stable, whatever happened. We were not fooled, although it took some time to come up with the formula ultimately written into Sec. 108 of the Humphrey-Hawkins Act. This specified semi-annual hearings, with the mid-year projections serving in part as a review of the accuracy of the forecasts made and targets set at the beginning of the year. Ultimately, the money-growth contraption fell by the wayside, as the financial system evolved (with, among other things, interest paid on checking deposits), and monetarism itself went out of fashion. What endured were the drift toward transparency in monetary policy, the use of the congressional hearings as the central forum for conveying policy intentions, and ultimately the direct statement of interest rate policy. Over time, Federal Reserve chairs became accustomed to dialogue with Congress, and the quality of these officials indisputably improved.
The Drafting of the Humphrey-Hawkins Act
What did not endure, but rather came and went over time, was the “dual mandate” – the statutory commitment of the central bank to “full employment” and “reasonable price stability.” The drafting committee that produced the language included Keyserling and Gross, and met periodically in the spring of 1976 in the offices of Augustus F. Hawkins (D-CA), chair of the Congressional Black Caucus and a Member whose career dated back to Upton Sinclair’s End Poverty In California (EPIC) campaign of 1928. I was by far the youngest participant, representing Reuss, and the only one with significant interest in monetary policy. The New Deal/Truman era figures were planners. They envisioned an apparatus to guarantee employment, in the public sector if necessary, by setting and meeting social and industrial goals, through the federal budget. If there were credentialed macroeconomists in the group, they were early post-war neo-Keynesians for whom multiplier effects and budget deficits were the primary tools. Interest rates hardly mattered to them and monetary control, not at all. I had a relatively free hand on the substance of Section 108, which merely specifies the timing and format of reporting to the Banking Committees. To the senior draftsmen, this was a minor provision; otherwise, it’s unimaginable that a 24-year-old could have played the role that happened to fall to me.
When Hawkins-Reuss went over to the Senate, and Senator Hubert Humphrey signed on, his staff (largely at the Joint Economic Committee, which he then chaired) reworked the language, downgrading the planning provisions in favor of macro-econometric forecasting and goals in the neo-Keynesian style. It was at this point, I believe, that definitions of “interim targets” – “full employment” as four percent unemployment and “price stability” as three percent inflation – came to the fore. This approach in turn made Humphrey-Hawkins acceptable to the Brookings Institution economists then dominant at the Carter White House. The planners took what they could get and called it a victory. I wrote a critical essay, “Why We Have No Full Employment Policy,” my first publication, for Working Papers for a New Society, and did not attend the celebration dinner after the bill was signed. Most of Humphrey-Hawkins was a dead letter from the first day. And yet, the hearings on the Conduct of Monetary Policy went on. I would staff them for Reuss until he left the Banking Committee chair to take over the Joint Economic Committee at the start of 1981, taking me with him.[5]
Volcker and Congress in the 1980s Recessions
As an effective mandate for monetary policy, full employment was worse than still-born. The Humphrey-Hawkins Act preceded by about a year the appointment – by President Carter – of Paul A. Volcker to chair the Federal Reserve. Volcker soon embarked on a crusade to restore the international dollar, crush America’s industrial unions, and in the process drive down the inflation rate, whatever the cost. A brief recession in 1980, amplified by credit controls, cost Carter the election. A much deeper one followed in 1981-82, as short-term interest rates were driven above twenty percent and unemployment, in October 1982, above ten percent for the first time since before World War II. As Binder and Spindel relate, Volcker spun a smokescreen of “monetary targeting” to cover what was an extreme high interest rate and high dollar policy, setting the stage for four decades of US financial hegemony alongside industrial decline. Through it all, the Humphrey-Hawkins hearings endured.[6] Volcker, unlike Burns and far more efficiently than his short-tenured, well-meaning predecessor, G. William Miller, was patient and largely forthcoming in dialogue with Congress. He instructed Federal Reserve staff to prepare detailed responses to written queries from Capitol Hill, which I would draft for Chairman Reuss about six weeks before each hearing.[7] Constructive discourse and destructive policy went hand-in-hand.
As the slump deepened in 1982, Reuss and I sought ways to pressure Volcker and his colleagues to reverse course and bring interest rates back down. A new law was out of the question. But since the Federal Reserve was a “creature of Congress,” in principle it could be bound for the duration of the legislative session, legally if not necessarily enforceably, by a Concurrent Resolution (in the manner of H.Con.Res. 133). For this purpose, language on monetary policy could be placed in the budget resolution. But what should the language say? Binder and Spindel note that the two chambers introduced differing language and quote a congressional staffer as describing the effort as “a disaster.” But this misunderstands the situation, at least from my point of view.
The problem we faced was that any budget language on interest rates would face overwhelming criticism, even ridicule, from economists, the press, the White House and the Federal Reserve. The solution was to draft two resolutions. One, introduced in the House by Majority Leader Jim Wright (D-TX), called for lower long-term interest rates. The other, floated by Democratic Leader Robert Byrd (D-WV) in the Senate, called for lower real interest rates, somewhat vaguely defined. Possibly it was the other way around. From my perch at the JEC I had access to staff on both sides,[8]and I drafted both versions. Thus, when one was attacked the other could be waved around, leaving open the possibility that something might end up in the final resolution, once the two chambers got to conference. Sometime that summer, the legislative liaison for the Fed, Don Winn, made a trip to the Hill to ask what, in my view, might make that danger go away. I opined that if interest rates were to start declining the buzz would subside. Soon enough, they did. Cause and effect remains obscure in such matters, but our purpose was to worry the Fed staff and Board. In this, we succeeded.
The NAIRU Doctrine and Greenspan’s “Put”[9]
From early 1983 inflation fell while GDP growth recovered, along with non-industrial employment, although overall unemployment remained high by all previous standards. These developments engendered two further responses within the economics profession. First, monetarism largely disappeared. With inflation down, money demand and money holdings soared, and the statistical relationship between money growth and inflation, the bedrock of Friedman’s argument, broke down. Bob Auerbach, the “honest monetarist,” changed his views and went off to do other things, eventually as an academic in California, returning later to investigate employment discrimination and other abuses at the Fed for Banking Committee Chair Henry B. Gonzalez in the Greenspan era. He would come to the LBJ School toward the end of the 1990s, aged about 70, to write and teach about the Federal Reserve for the rest of his life.
The second response was a kind of apologetics for high unemployment, the so-called natural rate doctrine or “Non-Accelerating Inflation Rate of Unemployment” (NAIRU) theory of the labor market. Originated by Friedman and E.S. Phelps in the late 1960s, this doctrine asserted an amazing fragility of the capitalist system – that any effort by government to reduce the unemployment rate would necessarily lead to not only to higher inflation, but to accelerating inflation, hyperinflation, and socio-economic collapse. There was, needless to say, never a shred of evidence that this was true. Prices and wages in advanced industrial economies are notoriously sticky, and hyperinflations are very rare. But you could prove the NAIRU’s existence with an assumption (about expectations) and a bit of algebra, starting with the traditional Phillips Curve relationship beloved of neo-Keynesians. The notion mesmerized economists, from center-left to extreme right, well into the 1990s, even as unemployment fell while inflation did not return.
The NAIRU concept gave license to the Fed to ignore the dual mandate, or more precisely to claim that “full employment” was any unemployment rate at which price stability prevailed. Thus monetary policy could and should focus on prices alone. As for Congress? Well, a Fed officer explained to Downey, Congress just got the economics wrong. It was a perfect triumph of dogma over law, dressed up as a triumph of science over superstition. And it had the added virtue that as inflation subsided, the Fed could claim credit for having mastered inflation expectations. And how, pray, did they do that? Why, by “forward guidance,” conveyed to Congress and declared to the public in the Humphrey-Hawkins hearings!
In this way Alan Greenspan converted a forum for the demonstration of congressional power into a cave of the Delphic Oracle – Greenspan himself – speaking in riddles and circumlocutions. Greenspan was a political celebrity and sometime consultant[10] with a PhD awarded by New York University for some previously-published articles, and then removed from their library and unseen – until after Bob Auerbach caught the whiff of academic scandal and wrote about it in a book. But he was affable and pragmatic, and he allowed unemployment to drift far below the estimated NAIRU, until by the late 1990s only fools and economists could still advance the construct with a straight face.[11]
Bernanke, Yellen, and the Return of the Dual Mandate
With the age of Ben Bernanke and Janet Yellen, the fully credentialed academic economist finally arrived at the helm of the Federal Reserve. And curiously enough, after a certain time, the dual mandate finally came into its own.
Bernanke is perhaps adequately described as a conventional economic ideologue clobbered by the real world. He grew up and prospered as a mainstream macroeconomist of the 1970s era, touched by monetarism, rational expectations, New Keynesian economics (not to be confused with the earlier version, neo-Keynesianism), and the NAIRU. All of this led him in the 1990s to the doctrine of “inflation targeting” – the idea that the central bank should focus on inflation, allow unemployment to reach its own level (“equilibrium in the labor market”) and seek price stability through credible projection and occasional manipulation of the Open Market Committee’s unique policy tool, the overnight interest rate on bank reserves.[12] Since with the demise of monetarism there remained no plausible link between money and prices, Bernanke was, perhaps without realizing it, a pure child of the Humphrey-Hawkins process. His instrument was psychological projection, from the congressional hearing room to the markets and the country and world beyond. It was a role for which as a modest and soft-spoken intellectual he was perhaps uniquely unsuited. But the press, accustomed to Greenspan, helped him out as much as they could. And he benefited from the larger reality (briefly acknowledged inGreenspan’s own memoir) that the decline and fall of the Soviet Union had inaugurated an era of low commodity prices, while the rise of China as a supplier of labor-intensive consumer goods put a ceiling on many other prices. That, plus the crushing of the industrial unions (and their associated industries) under Volcker, ensured that there was no inflation to fight.
It was under Bernanke, and his glib reassurances of a “Great Moderation” that would forever merge with Irving Fisher’s 1928 “stocks have reached a permanently high plateau” in the annals of foolish remarks, that US financial markets were swept by a vast wave of financial fraud, leading to the collapse of interbank lending in August 2007 and of the economy itself the following year. At this point, the Federal Reserve began to assert what Smialek calls its “limitless” power to buy assets no one else happens to want, flooding the banking system with cash, and – from early 2009 onward – paying interest on the cash! Since there was little deflation (outside of the fall of capital asset prices, which are by definition not part of current inflation or deflation), “inflation targeting” could hardly have justified trillions in such purchases. But with unemployment surging, the dual mandate easily covered the case.
It’s not that the Federal Reserve would not have acted without the full employment mandate. The European Central Bank, bound by charter to price stability first and foremost, went ahead and emulated the Fed. But the ECB had to lie about what it was doing. The Federal Reserve could invoke the 1978 law. From that point forward, under Yellen and Jerome Powell, her successor and the present Chair, the dual mandate regained an official respectability – which among economists, it had never enjoyed.
Conclusions: The Situation Now and What Could be Done
The Federal Reserve today is the most transparent of central banks – the absolute opposite of the institution that existed in 1975. Whereas then it pretended to hide its interest rate decisions in clouds of obfuscation and outright secrecy, today it announces them and also provides advance warning of future plans. The result in the public arena is roughly similar. In those days, the media went about guessing what the Fed had done; now it tries to read the tea-leaves of published remarks, hoping to find meaning in minor changes of wording or punctuation. The big difference is that fifty years ago the actions of the Federal Reserve mattered. Today, so far as the aggregate measures of the American domestic economy go, they do not.[13]
The difficulty facing the Federal Reserve now is neither Congress nor mandate, but the evanescence of the theoretical constructs on which the macroeconomic role of the central bank was founded. Neo-Keynesianism and monetarism died long ago. Inflation targeting, forward guidance, and expectations management had no effect on price increases in 2021-2022. Most surprisingly to the economists, Jerome Powell’s interest rate hikes, launched in March 2022, had no perceptible effect on growth or employment, hence no plausible role in bringing the inflation rate down. Monetary policy has become an empty set of rituals. When interest rates rise, the press reflexively reports that inflation is being fought; when they fall, the Fed is supporting growth and the labor market. But the gears are disconnected from the engine; the supposed causes no longer bear on the supposed effects.
The biting reality is that resource costs and global supply chains drive price increases. When inflation from these sources hits, some consequences are inevitable; others can be managed by direct actions – sales from storage, guidelines, even controls. Handing such problems to the central bank achieves nothing. In the era of interest payments on bank reserves, raising rates is a direct subsidy to the very rich, as well as a deterrent to loans for risky, long-term commercial, residential, and technical investments – including in low-profit-margin sectors like clean energy. If Trump’s Department of Government Efficiency wants to save real money in the federal budget, getting Congress to order the Federal Reserve to fix the federal funds rate at zero would be the right way to start.
What then should the central bank do? Jeanna Smialek tells of its limitless power to rescue the financial sector from its speculations. The other side of the same coin would be effective regulation to prevent the build-up of toxic speculations in the first place. That’s the necessary second step.
And then what? Robert Hockett points us back to the original purpose and structure of the Federal Reserve System, which was to ensure decentralized development and common prosperity across the entire country, through a robust system of directed credit administered by the twelve regional banks. Such systems have been the backbone of successful industrial and development policy everywhere in the world, including post-war Europe, post-war Japan, and modern China. They were also key to the rise of the United States in the twentieth century, when the Reconstruction Finance Corporation, founded under Herbert Hoover and vastly expanded by Franklin Roosevelt, superseded much of the private banking system and operated directly from the regional Federal Reserve Banks.
Biden’s industrial policy showed the drawbacks of attempting to revive industrial capacity without control of the credit system. Local control of infrastructure projects has meant a diffuse pattern of expenditures on roads, bridges, power lines, and suburban sprawl. Tax subsidies for energy and semiconductors mean that at the end of the day, corporations make the technical decisions based on their profit calculations and not on public purpose. The government cannot reach goals if it cannot effectively specify them and monitor progress toward their achievement. It cannot do this when the control of finance capital rests exclusively with private banks, still less if those banks are international in their outlook. The government either has the required instruments at its disposal, or it does not. Hockett tells us that it was for this purpose that the regional Federal Reserve banks were first designed.
The hope that this purpose might be revived is remote. But the opportunity to pursue it could be picked up by either party. Trump’s team may soon discover the limits of their tariff program and ask what else they might do. Or the Democrats, should they get serious about winning elections, and choose to break with the banks and move beyond Bidenomics, and not backward to the neoliberal globalism of Clinton and Obama. When pigs fly.
Notes
[1] The position of the twelve presidents on the Open Market Committee, where they vote on interest rates, is in flagrant violation of the Appointments Clause of the Constitution, a matter taken up by Reuss in a lawsuit styled as Reuss v. Balles. Balles was President of the San Francisco Fed and the first in alphabetical order of the twelve presidents. The lawsuit was pursued by a staff lawyer, Grasty Crews II, assisted by Bob Auerbach, and went through several permutations, being taken up by Senator Don Riegle (D-MI) and then John Melcher (D-MT) before finally being denied certiorari by the Supreme Court. No one ever contested the merits of the case; the various decisions (all adverse) were a tangle of standing issues.
[2] According to one story that I cannot now confirm, he (or possibly it was Henry B. Gonzalez, a later Chair and ally on these matters) once got the Fed to declare that its offices were in fact (tax-exempt) federal government buildings by persuading the District of Columbia government to send a property tax bill.
[3] Practically my first act on becoming Executive Director of the Joint Economic Committee in early 1981 was to agree to a request from Don Winn, legislative liaison for the Fed, to discontinue the letters. I did not report this to Proxmire and no one ever noticed.
[4] I cannot recall whether Bob Auerbach was yet on board.
[5] In the fall of 1976, I went off to obtain a PhD in economics at Yale, but I returned to the Banking Committee part-time in late 1977, and took responsibility for preparing the monetary policy hearings, a task I relished, leaving New Haven in 1979 for the University of Maryland where I taught 1979-1980, while still working on the Hill.
[6] At one point the law lapsed, but it was soon restored – at the urging of the Federal Reserve.
[7] A notable exchange concerned the 1980 effort by the Hunt brothers to corner the market in silver.
[8] I was connected to Byrd through staff on the Senate Democratic Caucus, notably Richard Medley, who I had hired for a House Banking Committee study in 1980 and later recommended to Byrd’s staff. Richard went on to co-found The International Economy magazine, to help George Soros break the British pound in 1992, and then to found Medley Global Advisers.
[9] Greenspan’s support for the markets and economy, in the face of various crises, was known as “Greenspan’s Put.”
[10] At the JEC in 1981, Republican staff requested that we subscribe to Greenspan’s newsletter, perhaps instead of one of the econometric consulting services (Chase Econometrics, Wharton Econometric Forecasting Associates, Data Resources, Inc.) to which we were subscribing. I had no objections on ideological grounds but rejected the proposal partly on grounds of expense, mainly after reading a few samples and deciding that they were junk.
[11] In 1997 I published an article titled “Time to Ditch the NAIRU” in the Journal of Economic Perspectives. Twenty-one years later the same journal was still noodling over the same construct, with a much-more-timidly-titled essay, “Should We Reject the Natural Rate Hypothesis?” by Olivier Blanchard, former chair of economics at MIT and former chief economist at the IMF. Blanchard did not reference my essay in his, even though he had published a paper in the same 1997 issue of the JEP.
[12] In 1998 Bernanke and three co-authors produced a book on inflation targeting, which I reviewed harshly in Foreign Affairs.
[13] To be sure, rising interest rates in the United States still have powerful effects on the housing market, as higher mortgage rates drive down prices and depress construction. And they cause trouble outside the US for countries whose debts are denominated in dollars. As Smialek says, the Federal Reserve is central banker to the entire world – but the rest of the world has no representation at the Federal Reserve, and only a few countries, China first among them, have insulated themselves from its power.
22 comments
Comments are closed.
James K Galbraith is always a favorite of mine, and this did not disappoint!
Please recall the term ‘innocent fraud’ which was introduced by Professor John Kenneth Galbraith in ‘The Economics of Innocent Fraud’, which was the last book he wrote before he died. He used the term to describe fraudulent concepts that were being sustained by the ‘conventional wisdom’ (a term he created in a previous book). The presumption of innocence by those perpetrating the frauds is characteristic of Professor Galbraith’s cynically gracious approach. Not to mention his call that the Republican agenda would search for a higher moral purpose in favor of selfishness.
Really like James’ gritty histories of working at the Capitol.
Thank you Yves. This is very informative.
Fun with Macro! A mini-tour de force. More from Galbraith please. The toppled shibboleths are all here. The Phillips Curve, NAIRU, M1, and implicitly the Loanable Funds Theory. The chronicle of an intellectual wasteland. Indeed, the Oracle of Delphi could have done better, but couldn’t print money for her rich clients.
Nice to hear about the elusive Jane D’Arista who I became familiar with in the early aughts. She was an early assistant in making my escape from under the dead-hand of economic orthodoxy through the internet.
Jamie opines, “…that resource costs and global supply chains drive price increases.” Cambridge in ’75? Please go over your notes from Joan Robinson’s seminar on imperfect and monopolistic competition. Luv you, man!
No comments to add. Galbraith insightful as always. Keeping this in file for future reference as I’ve had very similar conversations with coworkers regarding how effective interest rates are in changing the direction of inflation.
This quote stuck out the most to me in the article. One thing I’ve yet to see mentioned in any discussion on the Federal Reserve, and the intersection of interest rates, inflation, and current events is context about reserve requirements, what happened during COVID with their suspension, and why reinstating it wasn’t explored as an option for trying to lower inflation without hitting other sectors.
For context, the reserve requirement was suspended in March 2020, when lockdowns started. Prior to that, in recent history there had been adjustments to the threshold or money value needed to be subject to the reserve requirement, but the higher end was typically 10%.
My understanding is this is one of the ways the FED was able to quickly inject large amounts of liquidity into the American financial system, so that banks could underwrite and extend supplemental bridge loans and lines of credit either via PPP or other programs to support businesses who needed to shutdown during COVID. $1 trillion in new loans became possible for every $10 trillion in assets the bank possessed, assuming $9 trillion out of that 10 had already been lent out.
However, without reinstating the reserve requirement, there’s not much incentive for banks to park their money at the FED, or for banks to entice consumers to park their money in their bank. While interest rates for savings accounts and loans respectively increased, those rates were still lower than what one could expect as a return from the stock market or from flipping and renting out a house.
Thus much of the extra savings that would normally get locked in a bank vault to cool down inflation, ended up chasing the stock market or real estate, inflating those assets and creating a feedback loop. A loop where the increased nominal value from dumping money in them could be realized and leveraged further by taking out loans on that increased value. If you had $100,000 at the start of 2023, you could’ve been a chump and put it in some money market account and got 9% more after two years, or you could have put it in an SNP500 index fund and made 50% after two years. No brainer.
My speculation is that maybe the FED was reluctant to re-impose the reserve requirement after what happened with Silicon Valley Bank in March 2023, where more potential bank runs could have happened if banks would be unable to meet the reserve requirement after fully leveraging themselves, and then begin restricting withdrawals and outflows from them.
However, another part of me suspects a more conspiratorial reason. One I don’t have enough evidence to support, but am willing to speculate on if my assumptions about the reserve rate are correct.
This is a very good point. I will need to think about it but you are likely on to something. I was not at all keen about the shift to paying interest on reserves as the way to implement interest rate changes both as being a complete gimmie to banks and being untested (the old method, as you likely know, was open market operations via the New York Fed’s money market desk). Confirming my prejudices, the “repo panic’ was completely misunderstood. It was the result of the Fed never having tightened under its new system, not understanding how banks would respond, and being flat-footed about how to compensate for short term reactions.
Thanks for confirming I wasn’t crazy about this. I would never expect the talking heads on CNBC or Fox Business to bring up this point, much less their guests to bring up this point unprompted, but I was hoping that someone else would have entertained the thought and considered its plausibility on a more serious publication or platform for financial news.
My conspiratorial notion is, as esop mentioned in another comment, the “Innocent Fraud” of those who work at the Federal Reserve, and those “in the know” about J. Powell’s approach in recent years of combating inflation. Before getting into his approach, some more context about inflation.
As many readers here know, inflation can come in different flavors. Milton Friedman tried to popularize inflation as primarily a monetary phenomenon, in the demand-pull flavor: Too much money and not enough goods relative to that money. However, you also have cost-push inflation, where a critical good that’s used in the supply or process chain of multiple large sectors of the economy can cause increased prices across all sectors. The pandemic also provided a basis for re-investigating and refining theories of wage-price spiral and greedflation, or the ability of institutions with monopoly market power to increase profits in such a short period of time that those knock-on effects rise prices overall in the economy.
My suspicion is that the inflation increase that started in 2022 was multi-factor, and that all types of inflation, each maybe conventionally responsible for 2-3% overall or 10-20% in certain sectors, ended up having a multiplicative effect together.
Cost-push inflation was blamed on the “Trump Checks” or individuals getting unemployment benefits, but altogether, when including subsidies for businesses, as well as state and local governments and healthcare systems, the total stimulus ended up being $5 trillion. While its disingenuous to blame it on individual stimulus checks (Only 1.8 trillion out of those 5) That $5 trillion isn’t a number you can wave away when trying to explain inflation.
Demand-pull inflation however, also had significant influence on prices. Supply chain issues created critical shortages in fuel supplies, components for manufacturing vehicles, and construction materials, all necessary for building cars and houses and moving them and their necessary inputs around. All things most people in the United States need to live and work. Houses increased by 50% since the pandemic started, and cars by 30%, both outpacing CPI denoted inflation.
However, wage-price spirals and greedflation also can’t be dismissed. COVID caused a significant number of early retirements, either through disability from long COVID, excess deaths in the near retirement age category, or with the recovery enabling those near retirement who saw their assets not just recover, but even appreciate a significant amount by fall of 2021, who saw that time as their chance to cash out and stop working. Immigration also significantly dwindled during that time period, and many overskilled workers, those with college educations but were working in low level retail or service, ended up getting opportunities to become technology coordinators or other administrative assists when teleconferencing and work-from-home created a demand for people with some computer literacy skills to help with those activities.This exacerbated a labor shortage in those lower-wage jobs, forcing companies to dramatically increase wages for jobs like drivers and food servers, while also raising prices because they had enough market power to do so to not compromise on profits. Median wages increased by about 5% in 2021 before the rise in inflation, significantly higher that for many previous years.
So, with all of this in mind, what is Jerome Powell’s plan of action? He has a “dual mandate” to maintain stable prices, and full employment. But technically he has a triple mandate, which is the first two, and to maintain stability and prosperity in the banking system, to the satisfaction of the President of the United States and the Board of Directors of the Federal Reserve, who are appointed from a pool of its member banks and governors. That means making banks and the Congressmen privileged to own and/or get campaign funding from those banks, happy.
His primary tools are controlling the Federal Funds rate, Organizing open market operations, and tweaking the reserve requirements rates. However, all of these can really only affect the monetary sources of inflation. Improving or relieving a supply constraint, via investments/subsidies/etc, and coordinating negotiation/price controls for sectors of the economy are all fiscal policy, which require action and approval from Congress.
He can’t “Do Nothing.” That would not be seen as acceptable by the administration, or the people, while prices are rising. However, doing nothing might have been better than increasing rates. If there are supply chain shortages, then investment needs to be targeted in those sectors. Increasing Interest rates would discourage investment into those areas, especially into supporting new or upstart industries to address shortages, and would funnel money instead into already profitable and/or incumbent industries. It would be like expecting to benefit from a pro-biotic supplement when you’re on an antibiotic regiment to treat an illness.
He could reinstate the reserve requirements, maybe slowly over time, and coordinate with the Treasury to evaluate banks who cannot meet them and either acquire or rehabilitate them. But here is where we encounter the “innocent fraud.” While this might have been the best option to cool down monetary sources of inflation, while still keeping some investment happening because Interest rates were low, it would also require banks to for once in the last 25 years, take responsibility and eat the costs for excessive financialization and their recklessness during that time. Increase the reserve requirement, and banks have to go back to parking a good bit of their money. Combine it with keeping interest rates low, much lower than inflation, and that means banks end up seeing a good bit of their nominal wealth evaporate. While borrowing for most people still slow down, mainly those trying to finance a car or house, those lucky enough to qualify are at least not getting doubly hammered with high interest rates on top of dramatic increases in the principle to cover the cost of the car or house itself.
This is probably why Powell ended up increasing Interest rates and not the reserve requirement, even if he or others knew it wouldn’t actually do much to stabilize prices. He had the cover of conventional wisdom and statistics to show: “Well, employee wages have risen a lot recently, and we’ve been at zero and low interest rates for some time, so it makes sense we have to bring them back up.” Banks could then use the FED’s rate increase as an excuse to raise their own, and then have enough of their portfolio of loans make a return that could at least match, if not beat inflation rates. Financial institutions once again get away with not having to share in the pain of everyone else.
Thanks for this, and I believe it’s a very solid take on what’s going on. One thing I wanted to point out is that with all the layoffs that’s been going on in the tech sector and RTO plus the increase in the number of immigrants, one would think that inflation would be somewhat tamed, but it’s actually heading back up, and I think it’s because the Biden administration has been spending a lot more money than usual almost like a crisis is going on, it’s like pouring gasoline on top of fire, and if you like inflation, then imagine what will happen in the next crisis when the government REALLY turns on the monetary spigot, “print till has no value, baby!!!”
Thanks for this – I’m not a market or Fed watcher, but even from a distance there have been some very odd things going on with interest rates, inflation and growth post-covid – your explanation looks as good as any I’ve seen.
Right across the world we are facing some ‘interesting’ times – so many economic assumptions are going out the door and its really anyones guess how all the cards will fall. We could well find ourselves in the strange situation of the major economic blocks simultaneously falling into stagflation and deflation, and its anyones guess what happens then.
There’s something clearly rotten in the FED paying these interest rates, thanks for putting this on the spotlight. However, in line with the criticism of “innocent frauds”, let’s not be disingenuous about what happened. Powell often said, bold-faced, that he was raising the interest rate because “the labor market was too tight”. His main narrative — one that persists to this day, unfortunately — was that inflation was labor’s fault. There’s scant credible evidence of wages rising above inflation and abundant evidence of greedflation, increasing oligopolies and supply-chain shocks. NC published a piece on possible (or certain, really) corruption in regard to not taxing windfall gains of oil companies, which could have helped dampening the oil prices. Much could be done, it simply wasn’t done.
“But what could the central bank do?” Raise the interest rate, that’s what it does, since there was “too little” unemployment they can move on to the other target of the dual mandate. It just wouldn’t address the real causes of inflation. Galbraith’s piece is puzzled on why central bank lost the connection with the economy; except that it didn’t. Powell’s move made little economic sense and that’s why it failed to reached its purportedly “intended” target (I’d recommend Liz Warren’s discussions with Powell on this, there are short clips on her youtube channel. The elephant in the room was that she couldn’t blame Biden’s boomerang sanction’s on Russia or his ineptitude to take real action, but everything else disregarding Biden stands). The real target, though, was achieved. Coming back from covid, there were a lot of hirings and a fear that the working class could get strong for a change, so let’s drive the economy down to increase unemployment. A technique lauded by the likes of Greenspan and Yellen, an age-old FED tradition. I’m not in the USA, so I can’t comment on how employment truly is there. My hunch is stats are being cooked and underemployment is probably more prevalent than it seems. Not long ago there were many reports on shit jobs (in a nod to the late Graeber) on the rise. The mission seems to have been accomplished.
Just a remark on what you said: raising bank reserve requirements raises the FED rate all the same. There seems to be a confusion in what you’re saying, as if raising the reserves wouldn’t raise the federal funds rate. What the FED does, through open market operations or demanding reserves etc., is change the federal funds rate. That’s what the media calls the “interest rate”
Oh, and though this is largely conspiratorial, I do believe the interest rate hike could also have been thought to make the dollar great again, just as Galbraith says about Volker’s (in fact, there are more similarities there to be explored). Larry Summers and the usual suspects were very vocal in advocating for a strong dollar. Dedollarization is far away, but not at all impossible
I think the key question is whether reserve requirements are really linked to things that affect credit creation, and of course whether banks are prone to keep excess reserves for other reasons. It would be good to get Jamie to respond.
I found his typification of Bernanke’s biases apropos, I once had a long conversation with BB about Japanese policy and was long puzzled by his harsh condemnation of it. Since then I have come to appreciate the emptiness of the expectations mantra, as well as the irrelevance of modest changes in target interest rates on corporate investment and borrowing decisions, which rely on slow-to-change internal rules-of-thumb and opaque processes for compiling projections that align, for better and for worse, with what senior managers want to do. While I would add that Fed policy also affects car sales, manufacturing today is a small slice of the economy, and autos but a slice of manufacturing. Services simply aren’t much affected by interest rates, much less whipsawed in the manner need to render monetary policy effective.
Without considerable background in macro-economics a lot of this is lost in the weeds. It is largely about the complex effects of interest rates on the value of the dollar, employment, inflation and subsequent international finance and trade. However in the concluding paragraphs solutions are offered and lo and behold they require actions by legislature. As I suspected the biggest problem with the Fed is the legislature has abrogated their fiscal responsibilities in favor of letting the Fed take the blame. It appears to me that what Galbraith is saying is fiscal measures are more important to the mandates imported to the Fed than monetary measures and monetary measures are the only levers the Fed has to pull.
You are correct — the original sin is the abdication of responsibility by elected representatives by fobbing off on monetary policy what only fiscal policy can actually accomplish.
It’s an accountability dodge right from the very beginning.
Well, when budget changes affect government activity only gradually, and Congress can’t pass a budget on time. It really doesn’t matter that “Keynesianism” is a dirty word. We really don’t have macroeconomic policy tools, even the fiscal policy “fine tuning” advocates had realized that was unworkable by the 1970s.
Indeed, here’s an excellent history on this tradition of abdication of responsibility: Stephanie Mudge, Leftism Reinvented https://www.hup.harvard.edu/books/9780674971813
“It appears to me that what Galbraith is saying is fiscal measures are more important to the mandates imported to the Fed than monetary measures and monetary measures are the only levers the Fed has to pull.”
Excellent.
The first-person (mostly) account of these historical Congressional/Economic events illuminates the notion that we are led by poseurs, midgets, and most likely– greater Fools. You have every reason to grab whatever you can to make ends meet.
I say just end the “independence” charade and have the Fed reabsorbed into the Treasury whence it came and where it belongs …
Only thing lacking in this post is the agency pushing politicians and economists via funding …
DIGRESSION WARNING
from Galbraith’s embedded link to his piece in The Nation…
My chosen path took me through Gandhi’s thinking and MLK’s thinking. While I did run into the limits of those principles (for me), it wasn’t till way later when I encountered some thought-through limits on such that made much cosmic sense. Not referring here to academic rationalizations of violence.
Apart from maintenance and care-giving-service, true…those “most jobs” don’t embody the above mentioned mythology. I think it ends up that the reality of the good in the mythology [hard as it is to swallow] is that that is, it seems, where “aggression” belongs. Struggle against a challenge. If no aggression is exercised (as I understand it) the shadow feels cooped up…and will project [or IOW “normal” aggression gets cooped up]. And that’s where AFAICS the/a collective shadow can come into play…as in say post WWI Germany or via Russiagate today. And I do wonder how many Israelis are sitting in cubes all day (troll) posing or spying on people close at hand or thousands of miles away. It can’t be NEAR as stimulating a life as working-in-kibbutz. Have mercy, I lucked into such here in America by the skin of my teeth. Our assistant headmaster would read us the same message in assembly from numerous alumni. I can’t say “and we liked it!” (ha) re each day we were out there busting our butts, though enough of us did sort of get the meaning at the time. Now I feel so lucky it makes me feel guilty.
https://sites.google.com/view/somnus/psychoanalysis/erich-neumann