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1、Ill/March2024ReportReformtheFederalReserve,sGovernancetoDeliverBetterMonetaryOutcomesDanielKatzAdjunctFellowManhattanInstituteStephenMiranAdjunctFellowManhattanInstituteAboutUsTheManhattanInstituteisathinktankwhosemissionistodevelopanddisseminatenewideasthatfostergreatereconomicchoiceandindividualre
2、sponsibility.ExecutiveSummaryCentralbankindependenceiswidelyregardedasanessentialelementofeffectiveeconomicstewardship.Yetpureindependenceisincompatiblewithademocraticsystem.Therefore,anyparticularexampleofcentralbankindependenceWithinademocraticSyStemnecessarilyfeaturesaseriesofjudgmentsaboutthecen
3、tralbanksinstitutionaldesign.Theoverallgoalofthisdesignisdeliveringtheenomicbenefitsofacentralbankthatisinsulatedfromtheday-to-daypoliticalprocesswhilemaintainingalevelofaccountabilitythatademocraticsocietymustdemand.TheFederalReserve,srecordinrecentyearsraisesquestionsaboutwhetherithasbeenoperating
4、inlinewiththebestpracticesofcentralbankindependence.TheFed,suniquestructure,includingremovalprotections,lengthyterms,andprivateownershipoftheReserveBanksystem,isdesignedtoensuretheindependenceofmonetarypolicy.However,ouranalysisshowsthatinpractice,theFed,scurrentgovernancehasfacilitatedgroupthinktha
5、thasledtosignificantmonetary-policyerrorswhileallowingtheFedtheflexibilitytounwiselyexpanditsremitintoinherentlypoliticalareassuchascreditrationingandbankingregulation.Thisreportarguesthatimportantbenefitsflowfromacentralbankthatcanconductmonetarypolicyfreefromshort-termpoliticalpressuresandthattoen
6、abletheFedtodoso,itsgovernanceshouldbeoverhauled.WeproposeaseriesofreformsaimedatrecalibratingtheFed,sgovernancetoensurethatitremainsinsulatedfromday-to-daypoliticswhileenhancingitsaccountabilityanddemocraticlegitimacy.TheproposedreformsincluderestructuringthetermsofFedboardmembersandReSerVeBanklead
7、ers;alteringthestructureoftheFederalOpenMarketCommittee(FOMC)toenhancetherelativepoweroftheReserveBanks;reformingtheReserveBanksystemtoprovidemoreaccountabilityatthestatelevel;andcordoningoffnonmonetarj,-policyfunctionssuchasbankregulationandcrisisresponsefromtheFOMC.Thesechangesaredesignedtocreateb
8、etterincentivestoallowtheFOMCtoconductmonetarypolicyfreefromshort-termpoliticalconsiderations,partlybyintroducingwhatwecall“monetaryfederalismzztochecktheabilityoftheU.S.presidenttocompletelydominatethebalanceofpowerontheFOMC.ThesechangesalsoensurethattheFedcanoperatewiththenecessaryindependencetose
9、teffectivemonetarypolicywhilebeingaccountabletodemocraticinstitutions.IntroductionCentralbankindependencehaslongbeenconsideredanessentialelementforsuccessfulmonetarypolicy.Butcentralbanksarecreationsofpoliticalexigency,andpureindependenceexistsonlyintextbks.Thatshibbolethslike“independence“generally
10、deliversuperiorenomicoutcomesistakenasaxiomaticbytheenomicsandpolicycommunities.Inpractice,centralbankindependenceisintendedtoallowthepursuitoflong-termgoalsdespiteshort-termpoliticalvicissitudes,butitcanalsobestowpowerwithoutaccountability.ButrecentmisstepsattheFederalReservedemonstratethattheFedis
11、fallingshortoftheseaims,withattendantenomicconsequences.1.arge-scaleassetpurchasesfollowingthe2008-09financialcrisisdistortedtheallocationofcreditacrosstheeconomy.Theattempttotightenpolicyin2018hadtobereversedquickly.TheFed,sswiftresponsetoCovid-19isoftenlauded,butitsunilateraltransitiontoaframework
12、whereitexplicitlysoughttoovershtitsinflationtarget/itsexcessivemonetaryaccommodation,anditsdismissalofincipientinflationas“transitory?contributedtotwoyearsofdecliningrealincomes3andthehighestinflationinfourdecades.4Aclusterofregionalbanksfailedwhiletheirsupervisorswereasleepatthewheel,largelybecause
13、thebankstookinterest-raterisksthatwerereasonablebasedontheirsupervisorsforwardguidanceatoolusedbythecentralbanktoinfluencemarketexpectationsoffutureinterestrates.5Tliischeckeredrecordinvitesthequestion：Whyisasupposedly“independent“centralbankmakingsuchobviouserrors?Thesefailuresareduelargelytotheero
14、sionofthekeyelementsthattraditionallyunderpinnedcentralbankindependence.ScrutinyofFedrhetoricandactionsmakesitclearthattheFedhasmovedbeyonditstraditionalnarrow,technocraticroleandinsteadhaspursuedamuchmoreexpansivemonetaryandregulatoryagendathatismoreconsistentwithanexplicitlypoliticalinstitution.Th
15、eFed,smandatehasexpandedtoincludeinherentlypoliticalactivitiessuchascreditallocation,theselectionofeconomicwinnersandlosers,andbanksupervision.Furthermore,theFedhasitselfvoluntarilywadedintohighlypoliticaldebates,suchasurgingincreasedfiscalstimulus6aheadofapresidentialelectionandinrporatingenvironme
16、ntalnsiderations7intothefinancialregulatorj,framework.1.eadershipthatWaStraditionallyregardedastechnocratichasbeenreplacedwithhighlyqualified,buthighlypolitical,personnelwhomovefreelybetweentheWhiteHouseandtheEcclesBuilding.Worstofall,policyacuntabilityhasbeenabsent.Currentgovernancestructuresandpra
17、cticeslacknegativefeedbackchannels,soprpolicydecisionsdonotnecessarilyresultinconsequencesforFedleadership.Fedofficialscanrightlyfacepressuretoresignforpersonaltradingimproprietiesbutnotforruinouspolicyerrors.Inpractice,independencewithoutaccountabilityservesasashieldtoprotectthestatusquoatthecentra
18、lbank.ToredresstheFed,sinstitutionaldrift,WeproposeafundamentaloverhauloftheFed,sgovernance,focusedondemocraticaccountabilityandmonetaryfederalismwiththeaimofproducingbettermonetaryPOlicyovertime.BalancingAccountabilityandIndependenceThecoreofourproposalbalancesincreasedpresidentialoversightfortheBo
19、ardofGovernors,whichconfersgreaterdemocraticlegitimacy,againstastrengthenedsystemofReserVeBanks.8WerecommendshorteningboardmembertermsandclarifyingthatmembersserveatthewilloftheU.S.president,aswellasimposingbansontherevolvingdoorbetweentheexecutivebranchandtheFed.Heightenedpresidentialntroloverthebo
20、ardshouldbebalancedbyincreasingtheinfluenceoftheReserveBanks,whoseboardsofdirectorsshouldbechosenbystategovernorsineachdistrict,insteadoftheundemocraticspecialintereststhatcurrentlydominate.Anyreformneedstoweighcentralbankscontradictoryneedsofdemocraticlegitimacyandsufficientfreedomfromshort-termpol
21、itics.RatherthanpretendthatwecaneliminatepoliticsattheFed,weprefertorecognizethatpoliticalmotivationswillalwaysexistandtotrytoprovidemechanismstoblockthemfromundulyaffectingpolicy.Politicalindependenceisinherentlyundemocratic,andincreaseddemocraticlegitimacyinournationalinstitutionsisusua11yanendini
22、tself.However,inthetraditionalapproachtomonetaryeconomics,thisfundamentalprincipleisabsent.Ourreformproposalfocusesasheavilyonincreasingdemocraticlegitimacyasitdoesonimprovingpolicyoutcomes,attemptingtofindabetterbalanceinthetrade-offbetweendemocraticlegitimacyandpoliticalindependence.Thecomersoluti
23、onsofaFedwhollyobedienttopoliticians,oraFeduncontrollablebythecitizenry,arebothunacceptable.Moreover,ourproposalseekstoalterthegovernancemechanismsbywhichtheFedacts,withoutremovinganyofitspolicyinstruments.AlthoughlimitingtheFed,sspeofactionexantetopolicyapproadnesndonedbydemocraticallyaccountablebo
24、dieswouldalsoaddresstheFedsdemocraticdeficiteffectivecentralbankingdoesrequirepolicyflexibilitytorespondtoanuncertainfuture.CurtailingtheFed,sauthorityrequirestheabilitytoprescriptivelylayoutallenomicandpolicypossibilitiesinadvance,whichrunsrisksbothofallowinglpholesandpreventinglegitimatepolicyacti
25、onsthatmaybeneededinextremecircumstances.RatherthanlimitingtheFed,sabilitytoact,themorepragmaticapproachistoincreaseitsdemocraticaccountabilitywhenitdoesso.OurproposalembodiesthemostclassicAmericansystemofchecksandbalances:federalismbalancingincreasedpresidentialinfluenceontheboardwithanempoweredRes
26、erveBanksystem.AmonetaryfederalistframeworkthatdiffusespoweracrosstheFedsystemcansustainthefundamentalcontradictionbetweendemocraticaccountabilityandastrongdegreeofpoliticalinsulationthatisanecessaryingredientofeffectivemonetarypolicy.NationalizeandEmpowerReserveBanksCurrently,ReserveBanksareprivate
27、rporationsntrolledbylocalprivatebanks,nonprofits,andcorporations,withoutdemocraticlegitimacy.WeproposenationalizingReserveBanks,empoweringgovernorsofthestatesintheirdistrictswiththeselectionoftheirboardsofdirectors,which,inturn,willcontinuetoappointReserveBankleadership.AllowingReserveBankleadership
28、tovoteateverymeetingoftheFederalOpenMarketCommittee(FOMC)the12-memberbranchoftheFederalReservethatdeterminestledirectionofmonetaryPolicywillbalanceincreasedWhiteHousecontrolovertheFederalReserveBoardofGovernors.Thecombinationofthesetwoforcesratchetsupaccountabilitywithbetterpoliticaloversightand,for
29、thefirsttime,democraticlegitimacyfortheentireFedsystem.ThechecksandbalancesprovidedbymonetaryfederalismcanpreventtheFOMC,sincreasedaccountabilitytovotersfromresultinginmonetaryPoIiCythatistooheavilydictatedbythepoliticalpressuresofWashington.Suchasystemwouldbedesignedtosafeguardtheconceptofcentralba
30、nkindependencewhiledisincentivizingtheFOMCfromstrayingtoofarfromitscoremandate,orcarryingoutitsmissioninawaythatisinappropriatelypolitical.WefurtherproposeremovingovertlypoliticalresponsibilitiessuchascreditrationingandbanksupervisionfromtheBoardofGovernorsandputtingthemsolelyunderthejurisdictionofn
31、ewsectionsoftheFedthatwouldbedirectlysupen,isedbypresidentialappointees,asisappropriateforfiscalfunctionsoftheexecutive.Excessivecontrolbyelected,politicalactors(likethepresident)interferesingoodpolicyandresultsinbadeconomicoutcomes.Butdearly,toolittledemocraticoversightcreatesthepossibilityforapowe
32、rful,entrenchedFedthatmaydeliverpooreconomicoutcomeswithlittlerecourse.Weattempttochartmidwaybetweenthesetwo,balancingincreasedpoliticalaccountabilityagainsttheneedtokeepday-to-daypoliticsoutofmonetarypolicy.WearguethatbydilutingthepoweroftheboardinfavorofnewlydemocratizedReserveBanks,ourproposalbet
33、tersafeguardsindependencethancurrentlawdoes.Forexample,if,undercurrentlaw,apresidentattemptedtodismisstheentireboard(withorwithoutcause)andreplaceitwithaslateofnewnominees,thereisasignificantchancethattheSupremeCourtwouldsidewiththepresidentanddeliverdirectcontroloftheFOMCtotheWhiteHouse.Incontrast,
34、underourproposal,thepresidentsswayovertheFOMCisbufferedbyaReserveBankmajoritythathedidnotselect.Moreover,ourapproachwillempowerrepresentativesofdifferentregionsoftheeconomytomoreseriouslycontributetothesettingofmonetarypolicy.WebelievethatthisincreasedrolefortheReser,eBankswillreduceperniciousgroupt
35、hinkandincreasethefrequencyofdissentproblemsthatformerRichmondFedpresidentJeffrey1.ackerhasarguedcontributedtothepolicymistakesof2021.9ThetensionbetweendemocraticlegitimacyandindependentagenciesisexploredatlengthbyPaulTucker,whoarguesforpubliclyagreedself-restraintonbehalfofcentralbankerstotheircore
36、mandatesandpubliclyagreedconsensusamongpoliticiansandvotersonnarrowmandatesforindependentagencies.10WesharemanyofTucker,sconcernsbutviewsuchpublicagreementsasunlikelytocomeaboutanytimesoon.Therefore,WeseektoreformtheFedinsuchawayastoPreSerVeitsindependenceinthemodempoliticalclimate.Ourproposalcanbei
37、mplementedinapiecemealfashion,onepolicyatatime,iflegislativelyeasier.Howeverzbecausetheheartoftheproposalbalancesmoredemocracywithdecentralizedpower,thefullbenefitsrequireholisticimplementation.Inthisreport,webrieflyreviewthewaysinwhichFedindependenceandpoliticalneutralityhavebeenunderminedbyinterme
38、shingmonetaryandregulatorypolicywithfiscalpolicy,andthenwepresentourreformproposals.Next,weaddresspotentialmarketresponsestothereformproposalandrecommendaphased-inimplementationperiodtosupportmarketstability.Thefinalsectiondiscussesourproposalinthecontextofotherreformideas,howreformmightbepoliticall
39、yimplemented,andconcludes.1.ackofAccountabilityandMandateExpansionUndermineFedEffectivenessAsWehavenoted,thereisatrade-offbetweenindependenceanddemocraticaccountability.Allstakeholdershavebeenwillingtoacceptthistrade-offwhilethecentralbankdeliveredgoodoutcomesandremainedabovethepartisanfray,buttheFe
40、dhasgraduallybememorepolitical,anditsperformancehasbecomeworse.Gradually,theFederalReser,eexpandeditsnarrowngressionalmandateintoinherentlypoliticalfiscalterritoryandwadedintosensitivepolitical,social,andculturaldebates.Partisanfigureshavebeenplacedintopleadershippositions.Mostimportant,theFedsprivi
41、legedpositionhasenabledanabsenceofaccountability.AllthesedevelopmentshaveweakenedtheeffectivenessoftheFederalReserve.AdditionofInherentlyPoliticalResponsibilitiesBecauseoftwodecadesofsuccessfulmacroeconomicstewardshipunderchairmenPaulVolckerandAlanGreenspan,theFedacquiredareputationforcompetencethat
42、has(mostly)enduredtothisday.SuchareputationhasbroughtmoreresponsibilitiestotheFed,manyofwhicharenecessarilyfiscalandthereforepolitical.AssumingtheseresponsibilitieshasobviouslyerodedFedindependence.PiCkinqWinnerSQnd1.oSerSForexample,duringboutsoffinancialinstabilityinthelasttwodecades,theFedcreatedS
43、ection13(3)facilities(namedforthepartoftheFederalResen,eActthatauthorizesthem).11Section13(3)facilitiesallowtheFedtopurchasevirtuallyanydebtinstrument(e.g.,bonds,mortgages,loans,securitiesbackedbycredit-carddebt,andassetsthatlegallyobligatethedebtortopayinterestandtheprincipal)issuedbyaborrowernotin
44、abankruptcyorresolutionprocess.Facilitieshavecoveredwide-rangingcategoriesofdebt,suchasasset-backedsecurities,12commercialpaper,13municipalbonds,14anddirectloanstosmallbusinesses.15FollowingtheDodd-Frankreformsof2010,theFedneedsthepermissionoftheTreasurySeCretarytosetupafacility;butonceitisestablish
45、ed,theFedhasprerogativeoverterms,eligibility,andprices,andtheSeCretarycannotdirecttheFedtochannelcredittoaparticularsegmentoftheeconomy.Oversightbyanofficialaccountabletovotersisthereforelimited,despitethepoliticalnatureoftheselectionofwinnersandlosersbycreditrationinganddecidingwhomtoinfusewithcash
46、bybuyingdebt.Whogetscredit,howmuch,atwhatprice,andwithwhatllateralorotherrequirements?Shouldhaircuts16orborrowingratesonbondsbackedbystudentloansbehigherorlowerthanthosebackedbyusedcars?WhataboutonloanstosmallbusinessesonMainStreet?Andhowdoweaccountforordeterminedifferencesincreditworthiness?TheSear
47、eunavoidablypoliticalquestions,buttheyaredecidedbyFedoffialsclaimingtobenonpolitical.Moreover,since2008,theFedhasfreelyengagedinlarge-scaleassetpurdases(1.SAPs),sometimescalledquantitativeeasing,toreducebenchmarkgovernmentinterestrateswhentheshort-termpolicyratewasalreadyatthezerolowerbound.17Theuti
48、lityofthistool,pursuedoutsideacrisiswhentheFedthoughtthatinflationwasmerelyafewtenthsOfapercentbelowitsannouncedinflationtarget,hasalwaysbeendebated.GovernmentDebtWhilepurchasinggovernmentobligationsistraditionallyunderstoodasanappropriatetoolofmonetarypolicy,theFederalReSerVeunderformerchairmanBenB
49、emankeextendedquantitativeeasingtolonger-termgovemment-guaranteedmortgage-backedsecurities(MBS).Inahistoricpolicymistake,theFedundercurrentchairmanJeromePowellcontinuedbuyingMBSinto202218despiteunemploymentnearseven-decadelowsandhousingpricesalreadyup20%overayear,19whenitwasclearthatthehousingsectordidnotneedmorecreditsupport.Whereasloweringinterestratesaffectsallcreditmarkets,mortgagep
