Trouble at the Fed (and Elsewhere)

As U.S. President Donald Trump starts asking about whether he can fire the Chairman of the Federal Reserve, it is time to start asking how strong the protections are for politically independent central banks.  The answers are alarming: Trump is not the only one challenging central bank independence; he is also not the most successful.  Indeed, the challeges are widespread and they have been growing for some time.  That is reason enough to pick up Paul Tucker’s book Unelected Power — which was recently named by Foreign Affairs as one of the top books published in 2018.  If you want a taster, my review of Tucker’s book from Survival is below.  The punchline is that while people are right to be concerned that Trump would violate the independence of the Fed, that does not mean either the Fed or any central bank should be left entirely to its own devices.

The initial premise of Tucker’s book is that central bankers have more responsibility than they want. Ideally, they would focus only on monetary policy. Unfortunately, they have to pay attention to the stability of the financial system as well. And given the resources they have at their disposal to bail out the banks, it is easy for politicians to assume that central bankers can also bail out the rest of the economy. Indeed, politicians have an incentive to hide from their own responsibilities in stabilizing macroeconomic performance while at the same time pushing central bankers to the front line – making central banks ‘the only game in town’. This means that politicians can take credit for the boom periods and then blame central bankers for the busts. Moreover, people are quick to believe that the central bankers let them down or, worse, paid more attention to the needs of the banks than to the public at large. Hence, by giving too much responsibility to central bankers, politicians undermine the legitimacy of liberal democracy.

The challenge is to design central banks so that they have as much power and responsibility as they need to accomplish goals that only they can manage, without at the same time creating opportunities or incentives for central bankers to overreach their mandates or, what is more likely, for politicians to hide behind or scapegoat central bankers when things do not work out as planned. This is the challenge Paul Tucker addresses in his analysis of ‘unelected power’ and, importantly, Tucker makes it clear that the problem central bankers face exists wherever administrative agencies are ‘independent’ from direct political oversight in the setting and use of their policy instruments. Hence, whenever politicians appoint independent agencies as the trustees or guardians of some specific public interest, they inadvertently create the possibility for those agencies to emerge as ‘overmighty citizens’ – a term that Tucker uses repeatedly – whose actions inherently threaten the perceived legitimacy of liberal democracy. Central banks are extreme versions of this problem, but their position is not unprecedented; the army and the judiciary are in a similar situation.

There is a lot to admire in the ambition of Tucker’s argument and in the clarity of his analysis. He has given a lot of thought to this problem during his many years of public service and then reconsidered it anew during an extended period of reflection since he stepped down as Deputy Governor of the Bank of England. Moreover, his synthesis of experience and theoretical engagement is rich. Tucker is at his most compelling when writing about the dilemmas central bankers face, but his efforts to apply the argument more broadly warrant careful consideration. Indeed, Tucker’s engagement with the ‘administrative state’ is an important contribution to the debate about the current state of liberal democracy.

Perhaps the most important contribution made in Tucker’s argument, though, is about the need to equip independent agencies with some sort of ‘political override’ (p. 126) like ‘a “pause” or “regime-shift” button’ that will allow elected politicians to provide democratic oversight and accountability when an agency faces challenges that push it beyond the scope of its mandates. Such challenges could emerge as problems that are too big for the agency to handle; they could also take the form of conflicts between an agency’s different functional goals. In practical terms, this means that central banks should not have to choose between monetary and financial responsibilities, even though the two areas are functionally interconnected. Instead, central banks should be designed to pursue price stability and financial stability in parallel; politicians should also have clear guidelines and responsibilities to step in when central banks get into trouble. Such a regime is already evolving in the United Kingdom to a greater or lesser extent. How such a political override would work in the euro area is more complicated.

Unelected Power: The Quest for Legitimacy in Central Banking and the Regulatory State. By Paul Tucker. Princeton: Princeton University Press, 2018.

This book review was originally published in the October-November 2018 issue of Survival.  This post is based on the un-edited version.  You can read the published version together with other reviews published in that issue here.