Don Kohn, Christine Romer, and Federal Reserve Independence

Last week at an event at the Brookings Institution, Don Kohn discussed a paper he wrote, “Federal Reserve Independence in the Aftermath of the Financial Crisis: Should We be Worried?” Don Kohn was a longtime career official at the Federal Reserve Board – I first met him in 1980 when the Treasury, the Federal Reserve, and other agencies were looking into the silver market debacle of that period – who eventually became Vice Chairman of the Board before he retired from government service.

Not surprisingly, his answer to the question in the title of his paper is yes. He argues that the extraordinary actions that the Fed felt it had to take to mitigate the economic consequences of the financial crisis have increased the risk to the Fed’s independence in conducting monetary policy. He is particularly concerned by the threat of subjecting the Fed’s monetary policy to GAO “audit.” As he emphasized in his talk, “audit” in this context does not mean verifying financial reports but evaluating the effectiveness of Fed monetary policy by a Congressional agency. He admits that a GAO audit would not be catastrophic; the Fed, after all, could ignore GAO recommendations if it thought they were wrong. But he fears it would be a first step at eroding Fed independence in monetary policy. He argued at the event that the best way the Fed to prevent this is by following a successful monetary policy.

Christine Romer, who was the discussant of Kohn’s paper, agreed with his conclusion but differed as to why the Fed’s independence is being challenged. She argued that the reason is the current distrust of experts, whether they are monetary economists or climate scientists. She said that this distrust of experts is prevalent in part of the current Republican Party.

As Kohn admits, though, part of the reason there is a threat to Fed independence is that the Fed failed to prevent the financial crisis. I would go further than that. The Fed Board staff and some of the various research departments of the Federal Reserve Banks published papers during the Greenspan era denying that there was a U.S. housing bubble. Perhaps all that expertise was getting in the way of seeing what was perfectly obvious – one just had to compare rents to housing prices and also realize that the rate of increase in housing prices was unsustainable. Also, Chairman Greenspan refused to take any regulatory action when then Fed Board member Ed Gramlich warned him about problems with subprime mortgages.

With respect to the latter event, I would note that the Fed is less independent with respect to regulation than it is with respect to monetary policy. The Fed’s refusal to take regulatory action to address developing problems in financial markets and at financial institutions during the period preceding the financial crisis was not unique to the Fed.

I agree with both Kohn and Romer that the Fed’s actions under Chairman Bernanke were generally correct, though one could argue about particular actions or lack thereof (Lehman Brothers?). I also agree that the Fed should be independent in monetary policy, though I would be less worried about the GAO than Kohn. Interestingly, Peter Fisher, a former New York Fed official and former Under Secretary of the Treasury, suggested at the conference that he was less concerned than Kohn about the GAO in a question he asked him.

While I support Fed independence, that does not mean that the Fed should be insulated from criticism. Some of that criticism will no doubt be well reasoned in the future, and the Fed should consider it. There is a tendency at the Fed, which is apparent to those of us who have worked at other agencies which have dealings with the Fed, for there to be a certain amount of arrogance about their knowledge, wisdom, and abilities. Of course, that does not mean that all Fed staffers come across that way, but enough do to give that impression. There is, after all, a reason that William Greider chose the title Secrets of the Temple for his book about the Fed. In this respect, Bernanke has been good for the Fed. While he undoubtedly is very smart, he does not come across as arrogant or as someone who thinks he knows better than everyone else. He has also has introduced much more transparency at the Fed, even giving press conferences after FOMC meetings to explain Fed decisions.

As for Romer, while I agree that the attacks on climate scientists is unwarranted, I think she would have to agree that there is less consensus about monetary policy among economists than there is among climate scientists about global warming and its causes. The climate change deniers appear to be motivated by ideology; they have to deny that it is occurring because the solutions require government action, which they oppose in principle. Therefore, they are particularly subject to confirmation bias, grabbing any isolated facts that might give rise to doubts (hey, the hurricane season in the North Atlantic was less severe than predicted).   

While debate about monetary policy is to an extent fueled by ideology, there are legitimate differences among economists about what the ultimate outcome of quantitative easing will be. At the conference, Martin Feldstein, who served as Chairman of the Council of Economic Advisers in the Reagan Administration, also spoke at the event and expressed concern about quantitative easing. He would prefer, as everyone else who spoke on the subject agreed, that fiscal policy take some of the pressure off the Fed.  He favors more infrastructure spending in the current situation, and departs from current Republican orthodoxy in supporting this. I agree with him on this. More reliance on fiscal policy to mitigate the aftermath of the financial crisis would have been preferable to exclusive reliance on monetary policy after the initial, and too small, fiscal stimulus program had run its course.

In his appearance, Bernanke mostly disagreed about the concerns over quantitative easing. There is no settled consensus on this, and debate is healthy while the Fed keeps it monetary policy independence.