Since the financial crisis of 2007/2008, fingers have been pointed and voices have been raised in an attempt to find someone or something to blame for the blow up of the United States’ financial system. It is impossible to pinpoint where responsibility lies within a complicated web economic activity; however, the Federal Reserve of the United States was a key player throughout. Candidates in the upcoming presidential election will be promoting economic plans greatly influenced by the recession. By examining the Fed we are undoubtedly better able to engage with this discourse.
The Fed can be thought of as the “fourth branch” of government, the one they don’t bother to teach in elementary school. Unlike the other branches which are entrenched in a carefully constructed system of checks and balances, the Fed operates independently. The goal of this autonomy was to eliminate short-sighted monetary policy made by politicians worrying about reelection. Removing monetary policy from the purview of elected officials also removes it from the influence of voters
Furthermore, the Fed has one clear goal as an institution, to maintain low rates of inflation. This simplistic goal ignores the complexity of the United States economy. Imagine if colleges only looked at SAT scores and nothing else during admissions. Those who would score the highest could afford tutors, study materials, and to take the test several times ── a small percentage of the population. Similarly, while low inflation is hailed to be good for all actors in the economy it is mostly beneficial for a small sector, the financial industry.
(Graph I: Corporate profits by industry, 1964-2012 from the 2012 Economics Report of the President, Table B–91.)
The beginning of strict anti-inflammatory policy correlates to the steep rise in financial industry profits. With increased profits and a larger share of GDP, the financial sector became even more capable of lobbying to influence Fed decision-making. Since the Fed is not responsible to voters, its mode of thinking about the economy came to be in reference to the financial sector. This may have been further perpetuated by a series of chairmen all schooled at top universities in the country at a time when conflicting views in economics were stifled; it was taken as fact that neoliberalism, autonomous central banks, and little interference in the markets all led to a flourishing economy. Similar backgrounds led to consistent policy further bolstering the financial industry.
The financial industry played a pivotal role in the reinstatement of Paul Volcker, Fed chairman from1979-1987, in 1983. As when institutions supply funding for a political candidate, something was expected in return for this patronage. The secret recordings by Carmen Segarra, an expert examiner for the New York Fed, demonstrate how the financial industry bends the Fed to its will. This situation where banks co-opt regulators is formally known as “regulatory capture.” As exemplified in the ProPublica article “Inside the New York Fed” senior managers would halt investigations or question examiner’s findings rather than advocating for the just implementation of Fed policy. A bank-favoring culture undoubtedly harmed the average citizen as not only was Fed policy geared to satisfy banks, but sometimes they would not even implement their own mandates.
This system works in favor of those running it. Private banks not only influence monetary policy decision making, but also influence the implementation of Fed policies to serve their own interests. Politicians reiterate the need for an independent central bank, yet simultaneously disapprove of its monetary policies in order to shift accountability away from their own decisions. During the crisis however, the strict line of autonomy was blurred as the Fed had to coordinate its response with the Treasury and take an active role in requesting the use of fiscal policy, known to the public as the stimulus package. The actions taken both unilaterally and collaboratively by the Fed reinforced support for large institutions who excessively took risk before the crisis, but did not provide the same aid on a substantial level to everyday Americans who also took on excessive risk.
It is clear that during the crisis, the Fed had no choice but to take extreme action to save the United States from complete economic collapse; what is not clear is why the Fed was allowed to foster an environment where the danger of collapse was imminent. The great recession serves as a reminder of what can happen when a regulatory agency fails to regulate, and furthermore fails to be regulated.
One of the reasons the Fed has been able to obtain essentially unopposed autonomy is that the average citizen has difficulty joining in an educated discussion about the institution. The Fed communicates in the highly technical language of those in the field of economics. Moreover, the Fed often seems like a highly mysterious institution. After all, billions in liquidity were provided to foreign banks without public knowledge until the information was begrudgingly released years later.
How then can voters regain influence within the Fed? While it would be ideal for groups of citizens to have the same lobbying power as large financial institutions, this is an unrealistic goal. We must instead facilitate conversation in simple language about the Fed, encourage our representatives to engage in sustained monetary policy conversations, and push for the Fed’s goals to include more than just low inflation.
During the crisis the Fed expanded its balance sheets and acted to the extent of its powers to stabilize the system. It is time that voters demand the powers of monetary policy and financial regulation be used to promote shared prosperity and transparency.
(Title image via).
Bernstein, Jake. “Inside the New York Fed: Secret Recordings and a Culture Clash.” ProPublica, September 26, 2014. Accessed November 7, 2015.
“Corporate Profits and Finance.” In Economics Report of the President, B-91. 2012 ed. United States Government, 2012.
Roberts, Alasdair. The Logic of Discipline: Global Capitalism and the Architecture of Government. Oxford: Oxford University Press, 2010.