The Federal Reserve last week released transcripts of Federal Open Market Committee (FOMC) meetings that took place in 2008 amidst a worsening global financial crisis. Fed analysts, scholars and reporters dove quickly into the hundreds of pages of transcripts, portraying a Fed that misread the nature of the crisis and struggled to understand the depth of the crisis that was undermining the financial system even as they met.
Alongside financial and economic crises facing the Fed that year, the Fed faced a crisis as a political institution. It wasn’t until late 2008 that the Fed’s two top leaders seemed to recognize this existential element of the financial crisis. The Fed’s vice chair, Donald Kohn, observed in December that “Crisis management strains the normal collaborative and deliberative mode of Federal Reserve operations.” And as then-Chairman Ben Bernanke put it:
“Let me just say that, whatever difficulties we may have finding appropriate governance, it is certainly the case that the Federal Reserve Act did not exactly contemplate the situation in which we find ourselves today.”
The Fed’s institutional predicament took three forms:
First, the Fed faced internal governance challenges. Financial crises tend to centralize power within the Fed’s Board of Governors, much to the consternation in 2008 of reserve bank presidents accustomed to a seat at the FOMC table in making monetary policy. Granted, centralized power within the Fed is not new; for decades, Fed leadership has been concentrated in the hands of the Chair. But the Fed’s creation of countless emergency lending programs and bailouts of Bear Stearns and AIG in 2008 (powers of the Board of Governors, not the FOMC) led some of the reserve bank presidents to complain about the flow of power to the Board. The district bank hawks (Richard Fisher, Charles Plosser, and Jeffrey Lacker) pushed the FOMC to adopt limits on emergency lending to give the FOMC a role in overseeing lending programs. As Plosser argued, “once the Committee sets the precedent that the Board of Governors can assume sole responsibility for monetary policy, we run the risk of losing the strength and the diversity of views that the System has always brought.” Still, the dovish presidents were largely silent, suggesting that “governance” concerns were motivated in large part by the hawks’ policy objections to the Board’s lending programs and financial rescues. Bernanke in response stressed the importance of collaboration across the Fed even if consultation was not legally required of the Board in devising emergency programs. The complexity of the policy challenge seems to have stretched the Fed’s governing capacity, leaving the Fed on uncharted institutional ground.
Second, the Fed faced external constraints in making policy. Those limits are clear in the fate of Bernanke’s suggestion in December 2008 that the FOMC consider adopting a formal inflation target of 2% as part of its “nontraditional” policy tools to bolster the economy. Several FOMC members noted, however, that such a move would require congressional consultation, and there seemed little political appetite for biting off that challenge as the crisis unfolded. In Kohn’s words, “Having an inflation target won’t have any effect if it is repudiated by the Congress. As soon as we make it, it could have a negative effect.” Central bankers often point to Stanley Fisher’s 1995 distinction between goal and instrument independence, suggesting that central bank independence requires control over policy instruments. The fate of the Fed’s inflation target (not adopted until 2012) undermines the notion of the Fed’s autonomy to choose its policy instruments. Some members of the FOMC were unenthusiastic about an inflation target, so barriers to adoption arose in and outside of the Fed. Still, the discussion in December underscores the political bounds the Fed bumped up against as it tried to innovate at the zero bound.
Finally, Bernanke faced the institutional challenge of leading a polarized Fed. Disagreements within the Fed late in 2008 complicated Bernanke’s commitment to more transparent policy and the FOMC’s new reliance on “communication” as a tool to shape public expectations and understanding of the unconventional policies themselves. Bernanke voiced concern that disagreements inside the Fed would spill over into public, undermining the Fed’s ability to credibly commit to a particular policy path. Bernanke urged his colleagues that December: “given the state of confidence in the markets and in the economy, I hope whatever disagreements we may have that as much as possible we can keep them within these walls. With respect to the public, we need, as much as possible, to communicate a clear strategy going forward.” Given the crushing recession that was underway and would officially last well into 2009, putting the Fed’s best foot forward proved insufficient for reviving either public confidence or the economy. More disagreement and open discussion outside the Fed followed Bernanke’s call for external cohesiveness. Such debates no doubt reflected a more polarized political world from which the Fed was not immune.