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Politicize the Fed — just not with Judy Shelton

Jeff Spross

President Trump has not had an easy time appointing new members to the Federal Reserve's Board of Governors. His latest pick, Judy Shelton, doesn't look like she'll improve the streak: Shelton got grilled by the Senate Banking Committee on Thursday, and several Republicans as well as the committee's Democrats were left underwhelmed. Both Sens. Patrick Toomey (R-Pa.) and Richard Shelby (R-Ala.) expressed "concerns" after the hearing.

The fundamental complaint with Shelton among mainstream observers is that she would "politicize" the Fed. But that's an idea that deserves to be picked apart a bit, because there are actually good and bad ways "politicizing" the Fed could go.

No doubt, Shelton comes off as someone who would basically do whatever Trump tells her to. For years she's advocated a return to the gold standard, a stance that's frankly quackery. It would also generally lead to tighter monetary policy and higher interest rates, which Shelton called for in the depths of the Great Recession — a genuinely madcap position to take. Recall that the Fed's job is to balance job and wage growth against the risk of inflation, by raising interest rates to cool off the economy, and lowering them to give it a boost. Higher interest rates immediately after 2008 would've made the recession worse.

But Trump has made his desire for lower interest rates — so he can boast of a stronger economy — quite clear. In the last year or so, once she was in consideration for Trump's appointment, Shelton suddenly started advocating lower interest rates, and backed away from the gold standard at the hearing. She's pressed for other radical changes, like getting rid of federal deposit insurance, which she also disavowed last week. "There does seem to be a pattern of total flip-flopping," Sen. Chris Van Hollen (D-Md.) said at the hearing. "The only pattern that I see here is a political one, not an economic one, and I think that's what concerns a lot of people."

This is where we need to make a crucial distinction: Is Shelton the sort of person who would do whatever Trump specifically — and, by extension, the right-wing infrastructure around him — would tell her to do? Or would she simply do whatever the president and Congress tell her to do, whoever may be in charge in those two branches?

There is a profound difference between the two propositions. A Fed official who takes orders from a specific politician or group of ideologues would be craven and dangerous. Other tidbits from Shelton's past, particularly her indifference to her duties while U.S. director of the European Bank for Reconstruction and Development, suggest she may well be more interested in ensconcing herself in a particular crowd of powerful benefactors than actually being a committed public servant. Let's say Trump successfully gets Shelton onto the Fed, and then loses to a Democrat in November. Would Shelton deliberately try to tank the economy to set the Republicans and their next presidential nominee up for success in 2024? (Donald Trump Jr., anyone?) That would indeed be the bad kind of politicization.

But a Fed official who takes orders from the executive and legislative branches, regardless of which party controls them, would simply be someone who believes, as a matter of principle, that elected officials in a democracy should be the ones to set monetary policy. This too would be "politicization" of the Fed, but of an entirely different kind. Frankly, there's a perfectly rational argument that this kind of politicization would be a welcome change for the central bank.

There actually was a time when the Fed did just take its orders from elected officials. During World War II, the central bank set interest rates and structured the U.S. Treasury market at the behest of the Treasury Department, in order to finance the national government's massive war effort. Simply put, the president and Congress decided on fiscal policy, and then the Fed used its monetary policy powers in whatever way was needed to facilitate the broader economic goals of that fiscal policy. Notably, not only did this arrangement successfully rebuild the American military and help defeat Nazism, it also led to one of the most spectacular job markets in U.S. history, with national unemployment falling to a remarkable 1.5 percent.

But Federal Reserve officials chafed under their subservience to the Treasury Department. A series of escalating battles ensued, and in the early 1950s, Treasury agreed to allow Fed officials to set monetary policy under their own judgment. This independence from the executive and legislative branches has become a bedrock norm of modern U.S. economic policy, jealously guarded by experts and elites on both sides of the aisle. The argument is that the occupant of the White House, whatever their party or ideology, will always want to boast of a stronger economy, and will push for lower interest rates. And this could lead to runaway inflation.

Essentially, it's an argument that monetary policy can suffer from too much democracy, and should be insulated from policymakers who are accountable to voters.

There's a real potential perversity at work there. Let's say we face another major economic collapse like the Great Recession, and the president and Congress determine another massive fiscal stimulus is needed, to restart job growth. The Fed could decide that stimulus presents too much of a risk of inflation, raise interest rates, and completely cancel out the jobs boost of the fiscal policy. Fortunately, when we did pass a stimulus bill after the 2008 crisis, the Fed did the right thing and helped. But given the modern norm of Fed "independence," it was entirely free to do otherwise.

In fact, outside of the Great Recession, the results of the Fed’s independence have been lackluster. In the last four decades or so, it has chronically over-emphasized low inflation, while essentially ignoring its legal obligation to maximize employment. Joblessness rates have been brutally high for long periods, while wages have stagnated and inequality has skyrocketed. Quite likely, this is because of how deeply the Fed as an institution is entangled with the private banking industry. In practice, a Fed that is "independent" of the president and Congress is arguably a Fed that answers to wealthy elites and the financial industry.

This brings us back to Shelton. If she does indeed represent the bad form of politicization, she nonetheless needs to advocate for the other form of politicization, too. If Shelton is out to cravenly serve Trump's personal political interests, she needs a Fed that answers to the president and Congress more broadly. And she's pushed for just that, calling in late 2019 for the Fed to "pursue a more coordinated relationship with both Congress and the president."

That argument, in turn, has been cited by Shelton's critics for why she shouldn't be placed on the Fed. If Shelton is collapsing the distinction between the two types of "politicization" from one direction, her critics are also collapsing it from the other.

But we should be attendant to the nuances of the difference. Obviously, a political hack should not be allowed anywhere near the Federal Reserve's Board. But someone who simply disagrees with the norm of political independence for the central bank is another matter entirely.

Granted, there are plenty of ways we could reform the Fed to be more responsive to the interests of workers — and less responsive to the interests of the financial elite — that don't go so far as to turn the central bank back into an arm of the Treasury Department. But America is a democracy, where economic goals and policy are supposed to be set by the duly elected representatives of the people. It's perfectly reasonable to ask why an unelected institution as powerful as the Federal Reserve is permitted to not only ignore those decisions, but potentially even countermand them.

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