The commentary on the Federal Reserve's second round of quantitative easing -- QE2 to the headline writers, which always makes me think it's time for a cruise -- has been heavy, pro, lukewarm and con, though the stock market likes it. Bernanke himself has entered the fray with a column in Thursday's Washington Post defending the purchase of $600 billion in Treasuries, which critics, like James Grant, blast as simply "printing money." The argument -- deflation versus inflation -- is endlessly educational, but I have little (amend that: nothing) to add. What is interesting, however, is the question that began to emerge around the time the Fed stepped in to try to save Bear Stearns Cos.: the central bank and politicization. Indeed, it's a topic worth pondering two days after a bitterly fought, often bizarre political battle.
What do we even mean by the term "politicization," particularly when it's applied to a linchpin institution of the economy like the Fed?
It's a big, hairy subject. To some, the Fed has been "politicized" since the day it opened its doors in 1914. The very existence of a central bank was an intrusion into the free market, which explains in part why we kept forming central banks then shutting them down in the 19th century. A second level of politicization occurs when you consider the Fed's mission. In the days before the Great Depression, when a more decentralized Fed's center of power was still Benjamin Strong, the head of the New York Fed, the bank had a limited mission that involved providing liquidity in times of panic and -- its mission of all missions, like today's Bundesbank -- retaining a strong currency and thus low inflation. It was the era of the gold standard, a mechanism designed to do just that.
This, of course, represented a political choice, argued many from the Silverite West, the working classes, the indebted and Progressives. Hard money restricted liquidity and favored the rich and Wall Street, which in turn defended it as both prudential and the natural order of things. When the Great Depression hit, there was unanimity of opinion at Hoover's Treasury (under Andrew Mellon) and the Fed (Strong died in 1928, leaving no single uber-chairman like Bernanke; the system in the Hoover years of the Depression was led by a banker, Roy Young) that the economic woes resulted from excess -- and the Fed tightened the screws. The result: bank failures, massive unemployment and deflation. By the time Franklin Roosevelt was elected, the Fed had lost all credibility and, by the standards that had existed, was politicized by the New Deal to expand its core mission to restart the economy. FDR even ended use of the gold standard. That "mission creep," in the words of Grant, was made explicit after World War II with the inclusion of full employment into its brief.
The fact is, by bureaucratic standards, economic failure nearly always exposes central banks to political interference. This is the third level of politicization: loss of autonomy to its political masters. The Fed only began to regain its autonomy from the White House with the '50s post-war boom. The Fed officially broke with Truman in 1951 by announcing it would no longer support pegged interest rates, over two decades after the Crash of '29. And as Grant pointed out the other day, the Fed accepted 12 months of deflation in the mid-'50s without panicking. As a general rule, as the Fed saw its mission expand, the dangers of politicization -- that is, a loss of autonomy -- increased. The Fed could through monetary manipulation help or hurt the party in power, particularly around election time. Many insist the Fed's Arthur Burns came under pressure from Richard Nixon to reduce interest rates in 1972 to help his re-election campaign. Nixon, in turn, believed William McChesney Martin's Fed insured his defeat to John Kennedy in 1960 by raising rates. And Paul Volcker famously undermined Jimmy Carter's chances for re-election against Ronald Reagan by jacking up rates to kill inflation. (Was that politics or sensible, even heroic, policy? Well, it was policy that had a big political effect.) Today, the conspiracy minded believe that Alan Greenspan left rates low after the dot-com bust so long, thus helping to inflate the mortgage bubble, to help out George W. Bush.
Whether that's true or not will probably never be known; that's certainly not what Greenspan, who rejects the connection between monetary easing and the real estate bubble, will ever admit. Greenspan had clearly picked up the political clout during his long tenure to insure enormous autonomy (although he also seemed to worry about losing it). And Greenspan wasn't about to fight the need to create jobs. Indeed, since Volcker managed to quell the inflationary beast, job creation has assumed top billing. Jobs, of course, as we've just discovered in the midterms, are an intensely political subject; and "job creation" is a necessary mantra for both parties. In that sense, Bernanke's Fed is irremediably politicized, though not overtly partisan.
But again there's "politicized" and there's "politicized." The severity of the financial crisis, much of which was blamed on Fed action and inaction, plus the intimate coordination of Fed and Treasury during the crisis, opened the door to calls to rein in the central bank and stirred up libertarians in the Tea Party like Rand Paul that would like to see the Fed disappear. The Fed's enhanced role in systemic regulation, undercut only by the Financial Stability Oversight Board and the consumer agency, paradoxically offers another threat to its autonomy: A higher profile creates a bigger target. Bernanke did battle against a number of attempts to audit its operations (an initiative of Rand pere Ron Paul) and to reduce its powers, particularly in terms of regulation. To do so he engaged in what normally would be viewed as politics: engaging in town halls to explain what the Fed does, and, as he did today, writing newspaper columns. It's an odd sight: To battle politicization, he must act like a retail politician.
Bernanke is clearly acutely sensitive to his political problem. And that very sensitivity may explain his willingness to engage in QE2, particularly since the administration does not appear to have access to fiscal tools -- tax cuts, spending -- to stimulate effectively. QE is such a technical ploy that it's unlikely to become a matter of back-fence conversations. And Bernanke did wait until the day after the election to announce the program. All this is very tricky, however. To avoid further raids on his autonomy, Bernanke has to attempt a scheme that plays with the fire of inflation and that he long avoided. And to eschew overt politics he must engage in politics. There's no escape. The only nonpolitical Fed is the dead one.
Robert Teitelman is editor in chief of The Deal.