Book Review: The Power and Independence of the Federal Reserve

The Power and Independence of the Federal Reserve. 2016. Peter Conti-Brown.

As Peter Conti-Brown shows in The Power and Independence of the Federal Reserve, much of what investors know about the formulation and implementation of US monetary policy is wrong. To begin with, the term “Federal Reserve Board” is an anachronism. That entity was abolished by the Banking Act of 1935 and replaced with the Board of Governors of the Federal Reserve System. Furthermore, “Federal Reserve” is an adjective — as in “Federal Reserve Banks,” “Federal Reserve Notes,” and so on — not a noun, popular usage to the contrary notwithstanding.

In a more substantive vein, Conti-Brown, assistant professor of legal studies and business ethics at the Wharton School of the University of Pennsylvania, argues that the perennial question of whether US monetary policy is independent of political influence is far too complex to be answered with a simple yes or no. He devotes considerable space to challenging the notion that US Federal Reserve policy is — or should be — the work of technocrats solely and impartially dedicated to achieving low inflation and prosperity. Conti-Brown also refutes the belief that central bank independence is necessary in a democracy because politicians, if left to their own devices, would invariably print money to win reelection. In reality, politicians sometimes whip up public sentiment in favor of tightening monetary policy.

If readers find these points arresting, they may be positively alarmed by others raised in the book. For example, Conti-Brown states that the present design of the Federal Reserve Banks is “almost certainly unconstitutional.” He also points out that the Federal Reserve Bank of New York had no authority to organize the 1998 rescue of Long-Term Capital Management, a hedge fund for which it had no supervisory responsibility. Furthermore, the author describes the Fed’s legally mandated terms of service — 14 years for members of the Board of Governors and four years for the chair — as “myths” in light of actual practice (e.g., resignations and reappointments). The resulting balance between autonomy and accountability diverges from the legislative intent.

More broadly, Conti-Brown shows that legislation is a poor guide to how the Federal Reserve System functions. For example, the Fed’s system of funding itself from the proceeds of open-market operations is not authorized by statute. Surprisingly, the Federal Reserve Act of 1913 is silent on the question of whether the president can fire the chair. Nevertheless, according to Conti-Brown, Thomas McCabe, chairman from 1948 to 1951, was almost certainly fired, even though his departure was officially described as a resignation. Because of the many gaps in the governing legislation, personalities have played a larger role in the Fed’s evolution than is generally recognized.

An unfortunate aspect of the evolution is that, as the author bluntly puts it, the governance of the Federal Reserve System is “a mess.” One major problem is that the system is charged with both monetary policy and bank supervision, despite the lack of any theoretical justification for uniting the two functions under one roof. Conti-Brown offers several proposals for improving the sprawling institution’s governance, including making some staff positions (particularly general counsel) subject to presidential appointment, giving the Board of Governors the power to appoint and dismiss the regional Reserve Bank presidents, and removing the Reserve Bank presidents from the Federal Open Market Committee (FOMC). Conti-Brown also rejects some reforms that others have proposed, including annual audits of the Fed and adoption of a quantitative formula for setting monetary policy.

None of the author’s opinions on these matters are uncontroversial, but Conti-Brown buttresses his case with insights from the historical development of the Federal Reserve System, most accounts of which concentrate on its initial founding. As Conti-Brown recounts, the system was effectively founded again in 1935 and in 1951. Certain colorful details emerge from his chronicle. For instance, he reports that the only institutional innovations of G. William Miller, chairman from 1978 to 1979, were to limit discussion with an egg timer and, in reaction to then Federal Reserve Bank of New York president Paul Volcker’s devotion to cheap cigars, to make FOMC meetings smoke free.

Conti-Brown clearly researched the book meticulously. One quibble is that the reader might wrongly infer from the text that Montagu Norman (1871–1950), governor of the Bank of England, coined the phrase “Never explain, never apologize” to describe his approach to central bank transparency. For the record, the Oxford Chronicle of 7 October 1893 reported that “never regret, never explain, never apologize” was the favorite advice to young men of Benjamin Jowett (1817–1893), master of Balliol College, Oxford. In a rare lapse, the copyeditors overlooked the misspelling of the surname of John McCormack (1891–1980), Speaker of the US House of Representatives.

Throughout the recovery from the Great Recession, market pundits have focused intensely on hints by Fed chair Janet Yellen and various FOMC members regarding future interest rate actions. The Power and Independence of the Federal Reserve demonstrates that much of the expert commentary in the media proceeds from false premises about the central bank’s internal dynamics. Although practitioners should not accept all of Conti-Brown’s conclusions uncritically, they can assuredly profit from his debunking of conventional wisdom about a key driver of the financial markets.

More book reviews are available on the CFA Institute website or in the CFA Institute Financial Analysts Journal®.