Public Pressure Can Influence The Federal Reserve

Dean Baker

The Washington Post had an article on grassroots efforts to try to influence the Federal Reserve Board’s decisions on monetary policy. It would have been helpful if the piece provided more background on the Fed’s institutional structure and decision-making process.

The Fed’s decisions on monetary policy (e.g. raising or lowering interest rates and quantitative easing) are made by the 19-member Federal Reserve Open Market Committee (FOMC). This committee includes seven governors who are appointed by the president and approved by Congress. The term is 14 years, although governors rarely serve out a full term. The chair is one of the seven governors, although their term as chair is just four years.

The other 12 members of the FOMC are the presidents of the district banks. These presidents are essentially appointed by the banks within the district. Only five of the 12 bank presidents have a vote. The president of the New York bank always has a vote, with the other four voting slots rotating annually among the other 11 bank presidents. This structure ensures that the banking industry’s concerns will get a full hearing at Fed meetings. The concerns of workers whose jobs and wages depend on the Fed’s decisions may not be heard.

At one point the article discusses public protests against Paul Volcker’s decision to raise interest rates when he was chair of the Fed in the early 1980s. It tells readers that the protests did not affect Volcker’s decisions at all. Whether or not this is true, that does not mean that the protests had no impact on the Fed’s actions. Volcker had to get the support of the majority of the FOMC to get his way on monetary policy. If the protests affected the views of other members, then Volcker would have been forced to take these views into account in setting policy. For this reason the focus on Volcker badly misleads readers on the potential impact of public protests.

In assessing the potential impact of public protests on Fed policy it is perhaps worth going back to the 1990s when there were also some public efforts, sponsored by unions and community groups, to influence Fed policy. In the years 1995-1996 the unemployment rate was falling below the 6.0 percent threshold that nearly all mainstream economists considered a floor. The conventional view held that if the unemployment rate fell below this level it would cause inflation to start to cycle upward.

Alan Greenspan, who was not a mainstream economist, was chair of the Fed at the time. He argued that there was little evidence of inflationary pressures and therefore no reason to raise interest rates and slow the economy. He had to overcome the opposition of several prominent FOMC members, including the current chair Janet Yellen, who was a governor at the time. Because there were public efforts to keep interest rates down, Greenspan did not have to worry about a strong consensus in the policy world for raising interest rates. This made it easier for him to carry the day and keep interest rates low.

The benefits from this decision were enormous. By allowing the unemployment rate to fall below 6.0 percent (it eventually hit 4.0 percent as a year-round average in 2000) more than 5 million people were able to get jobs. Furthermore, the tighter labor market allowed tens of millions of workers at the middle and the bottom of the wage distribution to see sustained wage gains for the first time since the early 1970s.

And, for those deficit cultists in Washington, the lower unemployment and more rapid growth led to a large improvement in the budget situation. Instead of the deficit of 2.3 percent of GDP projected by the Congressional Budget Office for 2000, back in 1996, the government actually ran a surplus of 2.5 percent of GDP. This shift from deficit to surplus of almost 5 percent of GDP would be the equivalent of $850 billion in 2014, or to use the full 10-year budget horizon, the equivalent of almost $10 trillion in deficit reduction.

The moral of the story is first, that public pressure on the Fed can have an impact on its decisions, which otherwise are likely to be far too responsive to bankers’ concerns about inflation. The second, and at least as important, moral is that the consensus in the economics profession is often completely off the mark. This was certainly true in the 1990s when economists across the political spectrum agreed that the unemployment rate could not fall much below 6.0 percent without triggering inflation. The country would have paid an enormous price if mainstream economists had been able to determine policy back then. There is little reason to believe that the mainstream of the economics profession has a better understanding of the economy today.

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