A Progressive Fed
Public power over money is good.
If not for the relentless Capitol Hill drama surrounding President Joe Biden's economic agenda, the biggest story in American politics right now would be about the Federal Reserve. Over the past month, three top-tier officials at the central bank have been caught engaging in what looks like several million dollars worth of insider trading. Two have resigned, more may follow.
Boston Fed President Eric Rosengren, Dallas Fed President Robert Kaplan, and Fed Vice Chair Richard Clarida all conducted large, lucrative trades surrounding the central bank's emergency pandemic policymaking. This stuff is obviously bad, all the more so because it actually conformed to the Fed's ethics rules, which are mercifully now under review.
I doubt anyone at the Fed twisted monetary policy to suit their investment portfolios. More probable is that they simply cashed in on policy decisions after they had been made. If you know when and how the Fed is going to act, it's pretty easy to make a quick million or two in the market. That is a serious breach of public trust, even if it doesn't affect interest rates. We pay our central bankers handsomely (regional Fed presidents make more than the president of the United States), and they aren't paid to front-run the market. Sen. Elizabeth Warren (D-Mass.) is right to raise hell over it.
The Fed has been a frustrating institution for liberals throughout my lifetime, and sometimes that frustration clouds liberal thought on the central bank's actual role in the economy. Since the onset of the pandemic, there has been a tendency in various corners of progressive discourse to embrace right-wing or austerian ideas about monetary policy in response to well-intentioned progressive critiques of the Fed as an institution. Progressives are attracted to these conservative narratives because they typically cast the Fed as helping the strong dominate the weak — but they chart a course for disastrous policy.
There are plenty of legitimate critiques to be made of today's Fed from a progressive perspective: it's a bad bank regulator, it's been absent on the climate crisis, and it's too close to Wall Street (you can rephrase the latter in several ways -- it's undemocratic, monopoly-friendly, whatever). The insider trading scandal is its own outrage, and feeds public distrust on each of these other issues, compounding the gravity of the offense.
But there’s another line of progressive criticism that attacks the Fed's low-interest rate agenda and its most recent corporate rescue operations. You hear this from some unlikely allies. Teen Vogue has an ultra-woke version of the critique, anti-woker Matt Taibbi has a libertarian-populist version, Matt Stoller has an anti-monopoly version, and Stoller’s bête noire Ralph Nader has a version that bemoans the meager returns on certificates of deposit. My point here is not to litigate any of these worldviews, but rather to emphasize that different liberal/left sub-factions are seeing the situation similarly, whatever ideological priorities they happen to hold.
The basic thrust of the argument is that low interest rates make life sweet and easy for big corporate predators, who can do more of their bad predatory things thanks to lower financing costs. Stock valuations rise, the rich get richer, the powerful and corrupt thrive while the weak and ordinary are ignored. The critique has obvious rhetorical power, in part because aspects of it are correct — but it ultimately paints a very misleading portrait of the economic dynamics in play.
[UPDATE: Vasudha Desikan, who co-authored the Teen Vogue piece with Tracey Lewis, writes to clarify that their critique of the Fed’s pandemic-era policy does not extend to low interest rates as such. You can read their piece in full here.]
Careful observers of this space will note frequent references to the economist John Maynard Keynes, and we have reached the section of the blog where Keynes must make an entrance.* Though he changed his mind on the matter a few times, by the 1930s, Keynes had come to see interest rates as essentially a giant brake on economic activity. If you wanted to slow things down -- growth, productivity, employment, wage growth, whatever -- you could raise interest rates and voila! -- the economy would stop doing so much economy.
But while high interest rates were a very effective brake, low rates were an unreliable accelerator. They helped at the margin, but the critical policy lever — especially during a recession — was government spending, preferably at a deficit. This is what Keynes meant in 1933 when he wrote to FDR that trying to fix high unemployment with low interest rates alone "is like trying to get fat by buying a bigger belt." Note that Keynes was not arguing for smaller belts! While imploring FDR to spend big, he also called for "cheap and abundant credit and in particular the reduction of the long-term rate of interest."
Monetary policy changes the price of credit. Quantitative Easing, a more recent addition to the Fed's interest-rate management toolbox, specifically aims to lower the long-term price of credit. Most businesses need to borrow money to operate, and low rates reduce their borrowing costs, making it easier for them to stay in business and pay their employees. Raising rates, by contrast, raises costs or eliminates borrowing opportunities altogether, making it harder to turn a profit and often forcing owners to cut costs elsewhere; layoffs and bankruptcies ensue.
So while it is true that low rates help private equity firms and corporate conglomerates, it is also true that they help small businesses and people who rely on not being laid off for their income.
But only so much. Reducing a firm's financing costs isn't the same thing as creating customers, which are what businesses need to grow. For this, you need spending, and fiscal policy is spending. So if you want the economy to do more economy, you lower interest rates and ramp up public works and transfer payments.
A lot of things happen when the economy runs hot. Profits and wages increase, and eventually prices do, too. When companies are profitable they do all kinds of stuff -- they merge, they issue stock options, they pay dividends and package complex structured investment products. All of this can, under particular circumstances, result in deeper levels of inequality, corporate concentration, inflation and other undesirables. These evils are not the result of low borrowing costs per se, but of high levels of economic activity facilitated by low rates and assertive fiscal policy.
Fortunately, there is tax policy, which can be used to reduce inequality (or tame inflation). And also antitrust policy, which can be used to curb corporate concentration. And financial regulation, which can limit dangerous speculation. Thus we arrive at the policy cocktail of the mature New Deal years -- low interest rates, high levels of public spending, very high marginal tax rates, serious antitrust enforcement, rigorous financial oversight.
The key takeaway is that monetary policy is not a great tool for addressing a lot of economic problems -- it's just the tool we've relied on most heavily since Paul Volcker became Fed Chairman in 1979. Volcker's program is a cartoonish exaggeration of what today’s rate-raisers are calling for, but it's useful for understanding how this mechanism works. Volcker raised rates dramatically and brought down both inflation and, for a time, economic inequality. Prices fell, and so did the value of financial assets owned primarily by rich people.
But Volcker also created mass misery. The unemployment rate jumped to 10 percent and Black unemployment went to 21.2 percent. Small businesses failed, farmer suicides soared, and Wall Street pay rose to record levels.
Progressives rightfully cried foul, and the Fed's subsequent regulatory lapses in the mortgage market and the outrageous structure of the 2008-9 bank bailouts (enjoy your bonuses!) only deepened left-wing disdain for the institution.
The Fed has never really addressed a lot of those complaints, as indicated by its current insider trading scandal. But that is not to say the institution has not improved in important ways. It's good that low rates are the norm now — they clear the way for other progressive policymaking. It's also good that the Fed's emergency corporate aid during the coronavirus crash came with some strings attached -- prohibitions on dividends, stock buybacks and executive pay -- unlike the bailouts of 2008-9.
Since Volcker, it has been easy to tell the story of the Fed as a Wall Street-friendly engine of inequality. But the central bank is not congenitally pro-rich. Public control over the monetary system was a top priority for 19th century populists, 20th century progressives, and the New Dealers of the 1930s, all of whom wanted to use that power to secure low interest rates to help advance progressive priorities. A better Fed would be more democratic and more creative about exercising its power on behalf of working people, but its agenda would include something very like the interest rate program we've seen over the past few years.
*Though it has no real bearing on his later economic analysis, any piece that discusses both Keynes and insider trading should note that by any reasonable definition, Keynes engaged in insider trading over the course of World War I. During the war, Keynes had privileged access to all kinds of economic data — from military purchase orders to the price of milk. He was also speculating in commodities markets and making a lot of money. There’s no evidence that he steered public policy to enrich himself, and at least one example of a case where he advocated against his own financial interests, but the arrangement would be considered wildly inappropriate today. Outside the Beltway, at least.