Many in the Federal Reserve—both the Board of Governors in DC and the reserve banks around the country—have come to view low inflation as the main threat to the economic recovery. Fed Chair Janet Yellen is the most prominent advocate of this view, and Chicago Fed chief Charles Evans is among its more prominent reserve bank proponents (see this interview yesterday with the New York Times). The Bank of Japan and the European Central Bank are now laser-focused on the same problem. Those institutions, along with Japanese Prime Minister Shinzo Abe, have staked their reputation on the power of monetary policy to stimulate economic growth, and there are growing calls in and outside the Fed for the US central bank to do more.
The basic problem everyone is trying to address is that with inflation expectations low—and they have been very low since 2008—firms and individuals have little incentive to invest or take other economic risks, which means the virtuous cycle of spending and hiring leading to more spending and hiring hasn’t really had the opportunity to get going.
The Fed has sought to address this collective action problem through something called unconventional monetary policy. This has come to mean the use of unusual monetary measures to stimulate demand. The scope of this authority is unclear. I will soon be writing more about it here and at Miles Kimball’s blog, Confessions of a Supply-Side Liberal. Miles, an economist at the University of Michigan, has written extensively on how to combat the so-called Zero Lower Bound problem. This is shorthand for when the economy is stuck in a rut for an extended period and the Fed’s conventional policy channels for increasing demand are gummed up: it can’t stimulate lending by reducing interest rates (because it has already cut them to near-zero) and it can’t juice inflation by expanding the money supply (because people aren’t spending the money in the first place, so merely increasing the supply doesn’t devalue it).
The general question I’ll be looking at is, how far can the Fed lawfully go in unconventional policy beyond what it’s already done. The Fed’s most prominent use of unconventional policy post-crisis took the form of the three consecutive rounds of “quantitative easing,” during which the bank bought US government bonds and government-backed asset-backed securities (Fannie and Freddie mortgage-backed securities (“agency MBS”)). Many economists believe quantitative easing served as a major stimulus to the economy and was particularly helpful given the inadequacy of the 2008 and 2009 fiscal stimulus measures. However, many “dovish” economists and Fed officials (seemingly including Yellen and Evans) want the bank do more.
When I began to look at the legal dimension of monetary policy—after all, that policy is conducted pursuant to a legal mandate—I was surprised to find very little in the way of scholarship or (publicly available) policy guidance…
Fed officials and outside observers have long suggested that the Fed lacked the authority to expand the bank’s QE program beyond US government bonds and agency MBS. While Fed officials haven’t revised that view publicly, one might reasonably begin to question whether they doth protest too much. In recent testimony at the trial of former AIG CEO Hank Greenberg’s suit over the Fed’s bailout of AIG, Fed officials for the first time acknowledged the existence of something the NY Fed actually refers to as the “Doomsday Book,” which is a multi-hundred-page book kept in the basement of the NY Fed that outlines the legal parameters of what the bank can do in the event of a crisis (!). The Fed has thus far avoided having to turn this over, so we can only speculate about what it contains, though the existence of the Doomsday Book tends to confirm this view that the bank has more firepower than it lets on.*
As I will discuss in upcoming posts, my initial review of the sources of law governing the Fed (about which very little has been written) suggests that the bank has significantly more monetary policy firepower than is commonly assumed. I personally believe this expansive power is a good thing: the Fed is charged by statute with a dual mission of promoting full employment and “price stability,” and given the importance of that mandate—as illustrated by the continuing weakness of the economy and the extraordinary human suffering it’s caused—it’s important that those terms have real meaning and not be aspirational only. (“Price stability” has normally been taken to require monetary tightening to keep the economy from overheating, but if the Fed’s inflation target is not being met there’s no reason the same term couldn’t permit loosening in order to stimulate the economy.) Further, Congress gave the Fed a broad mandate in the Federal Reserve Act of 1913; for good reasons, it chose not to set monetary policy legislatively. Given how broadly that statute is written, it’s hard not to see the delegation as a deliberate choice, and one that favors a functional interpretation of the statute (literal interpretations of the Federal Reserve Act are often not fruitful exercises).
So those are my (dovish) priors. If one is an inflation hawk, however, there’s even more reason to want a clearer sense of the legal scope of the Fed’s authority. Presumably a hawk would want to restrict the Fed’s authority to stimulate the economy and would want to know where the lines are that circumscribe the bank. Burnishing his hawk credentials, Texas Governor Rick Perry once famously branded then-Fed Chairman Ben Bernanke’s monetary policy “treasonous” and rhapsodized about Texas-style dangers to Bernanke’s safety if he set foot in the state. So it’s safe to say that this subject appeals to cowboys, economists, and policymakers alike, as well as legal academics. More soon.
*Interestingly, officials have conceded that the Fed broke the law a few times during the crisis, to facilitate bank rescues (essentially without legal consequences). So there’s even some question about the enforceability of the constraints on the Fed that do exist.