When the Federal Reserve came up with $85 billion in 2008 to rescue AIG, the insurance giant that gambled and lost on derivatives, Rep. Barney Frank, then chairman of the House Financial Services Committee, asked Fed Chair Ben Bernanke where he got all that money. According to Frank, Bernanke responded: “I have $800 billion,” referring to the Fed’s portfolio of government bonds and loans. Frank’s reply: “No one in a democracy, unelected, should have $800 billion to spend as he sees fit. That’s not the way to run a democracy.”
Lev Menand agrees.
A Columbia Law School associate professor who did stints at the Obama Treasury Department and the Federal Reserve Bank of New York, Menand argues in a slim paperback — “The Fed Unbound: Central Banking in a Time of Crisis” — that the Fed has been forced to stray from its roots by the evolution of the financial system, to which Congress has failed to respond. The result, he argues, is that the Fed has done too much and that this, among other things, has widened wealth inequality in the United States.
He largely absolves the Fed of blame for this (though I would have noted that the Greenspan Fed was reluctant to use the regulatory muscle it did have). Menand does, however, suggest that if the Fed hadn’t been so quick to act, Congress might have done more to repair the flaws in financial oversight and macroeconomic management that he identifies. “With Fed-led macroeconomic policy tailor-made to advance their interests,” he says, “why would asset owners seek other responses from Congress?”
The core of Menand’s historical and legal argument is that the Fed was designed not to stabilize the economy but solely “to administer the banking system.” He argues that its mandate is not to use its tools to deliver price stability and maximum employment (as the Fed itself and almost everyone else reads the law) but, rather, to grow the money supply at a rate consistent with the economy’s full potential. “Its job is to ensure that a lack of money created by the [private] banking system does not prevent the economy from achieving these goals over the long term,” he says.
That may be what Woodrow Wilson and Congress were thinking in 1913, but Menand disregards more than half a century of economic thought. He even declares in a footnote that “arguments that the Fed should raise interest rates to prevent prices from rising above a certain annual rate are inconsistent with its mandate” because higher interest rates discourage business investment. (He lost me there.)
Several of Menand’s policy recommendations are sound, even if the arguments he uses to get to them are a bit tortured.
Yes, financial powerhouses outside the perimeter of bank regulation — money market mutual funds, investment firms whose short-term borrowing resembles bank deposits and, lately, stablecoins, the crypto currencies that promise holders can convert them into U.S. dollars at a fixed rate — pose risks to financial stability that remain unaddressed more than a decade after the global financial crisis.
Yes, Congress should expand automatic stabilizers — enhanced unemployment benefits, aid to state and local governments, perhaps stimulus payments to low- and moderate-income households — that turn on when the economy stumbles and turn off when it recovers.
Yes, Congress should do more to increase the supply of housing to bring down its cost, and make the health-care system more efficient and less expensive, even though that wouldn’t do much about today’s inflation.
Yes, the Fed is not the arm of the federal government best suited to take the lead on fighting climate change, even if elected politicians are paralyzed.
Menand does offer a clear, textbook-style history of the founding of the Fed and an explanation of what it actually does in the money markets; that alone is useful. He correctly observes that in the fall of 2019 the Fed intervened in the market for U.S. Treasury debt because of dysfunction in that market, which returned with vehemence in the early days of the pandemic. And he briefly makes the case, as he has elsewhere, that the Fed should offer no-fee bank accounts to all “to rectify predatory and exclusionary practices in the investor-owned banking system that have significantly harmed low-income and minority communities by making it hard (if not impossible) for many households to open and maintain bank accounts.” He does not in this volume, however, discuss the potential for such accounts to destabilize the banking system in a crisis, nor does he acknowledge that this would substantially expand the role of the Fed in the economy, a role that he thinks is already too broad.
We do tend to ask too much of the Fed. When the shadow banking system, its growth insufficiently addressed by Congress and regulators, threatens financial stability and prosperity, we expect the Fed to save us. When Congress is slow to rescue the economy from a recession or turns the spigot off too soon (as it did in pre-pandemic times), we count on the Fed to do more. When elected politicians fail to cope with some pressing problem — inequality, climate change — there are inevitably those (many aware that the Fed can spend freely without congressional approval) who demand that the Fed step in. And as Menand argues, echoing warnings from Paul Tucker, formerly of the Bank of England, when unelected central banks tread too far onto the turf of elected representatives, they risk undermining their legitimacy and their ability to achieve their mandate of maximum employment and price stability.
David Wessel is the director of the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institution and the author of “In Fed We Trust: Ben Bernanke’s War on the Great Panic.” His latest book is “Only the Rich Can Play,” the story of Opportunity Zones.
The Fed Unbound
Central Banking in a Time of Crisis
By Lev Menand
Columbia Global Reports. 176 pp. $15.99.