Fed Independence and Accountability: A Debate with Sir Paul Tucker

[00:00:00]Were Fed independence repealed today, long bond yields would go up, I think, quite a lot and the currency would fall and probably equities would fall and the rise in interest rates on average in the future would hurt people. The rise in inflation expectations and then eventually the rise in inflation or the deep recession to avoid the rise in inflation expectations would hurt people. And actually quite quickly people would say, "Well, actually, an independent central bank is quite a good thing, isn't it?" [music] >> I'm Bethany Mlan.

[00:00:34]>> Did you ever have a moment of doubt about capitalism [music] and whether greed's a good idea?

[00:00:39]>> And I'm Luja Zengales.

[00:00:40]>> We have socialism for the very rich, rugged individualism for the poor.

[00:00:46]>> And this is Capitalism, a podcast about what is working in capitalism.

[00:00:50]>> First of all, tell me, is there some society you know that doesn't run on greed? And most importantly, what isn't?

[00:00:56]>> We ought to do better by the people that get left behind. I don't think we should have killed the capital system in [music] the process.

[00:01:04]>> So, the episode you're about to listen to was recorded before this week's stunning news about the Justice Department serving some penas on the Federal Reserve. Leuigi and I are going to have an additional conversation to discuss that news and what it means.

[00:01:19]However, we think that this news actually makes this episode all the more relevant.

[00:01:26]The Federal Reserve is the most powerful economic institution in the United States and arguably the world. It can raise your mortgage rate, move the stock market, throw millions out of work, or rescue the financial system, all without a single vote from the public. We call that independence.

[00:01:42]>> The economic justification for independence is very simple. If politicians run monetary policy, they goose the economy before an election and leave us with inflation afterwards. So, we handed that power to technocrats.

[00:01:58]>> But here's the twist or one of the twists. This independence can protect the Fed from politicians, at least arguably until recently, but not necessarily from Wall Street. In fact, Luigi, you've argued that the more independent the Fed is from voters, the more dependent it is on Wall Street. Why would why do you say that and why would that be? Because at the end of the day when uh you are a bureaucrat you want to have a objective function and if you're not accountable to the political system then you're accountable to your career incentives and the career incentives are naturally in the direction of pleasing Wall Street because uh when you step down you're going to either work for Wall Street or give speeches to Wall Street which is a very profitable uh activities uh that people do once you remove something as big monetary policy from democratic uh politics and you live in the hands of technocrats, people start to feel shut out. And that opens the door for a populist leader to say, why are these unelected bankers running the economy? Put me in charge and I will tell them what to do.

[00:03:06]>> Not surprisingly, this is exactly what is happening under President Trump. In this fight between Trumpian and independence, our concerns about capture and democratic accountability have been lost. To bring them back into focus, we decided to invite Sir Paul Tucker, former vice president of the Bank of England and author of several books, including unelected power, where he argues that what he calls delegation with insulation is legitimate only under strict conditions, clear goals set by elected politicians, limited tools, no open-ended missions, and strong transparency and accountability.

[00:03:43]>> Welcome to uh Capitalisent, Sir Paul Tucker. you were a civil servant and this term is often used in Europe but rarely in the United States. Can you explain to our listeners what a civil servant is and why this term is not very much used in the states?

[00:04:00]>> It's a very interesting question.

[00:04:01]Actually, I wasn't a civil servant. I was a I was a public servant, but I wasn't a civil servant. But in terms of what you're getting at, you want some permanent officials that live by norms of fidelity to the elected government of the day, who know their way around. And you absolutely definitely want some elected officials at the top and around the political parts of any of the great um departments who can provide direction to those below them and they will follow. If that is not the case, if there is obstructionism within the machinery of government in in Washington, that would be a very bad thing indeed. And you do get elements of that. I mean, if British people are amazed with certain things that have happened in the United States over many decades where a president has given an order to the military, say one about Guantanamo Bay, and it seems not to be carried out. This is a strange thing that should be I mean how can that happen? But look that the norms of of governance in Washington have been eroding for quite a long time is widely recognized and the interesting thing is it's social norms that keep these things alive. It's a kind of social um public or professional crowd sanction. You know you can't do that. It's never quite the letter of the requirements because however full even if the letter of a constitution said obey this constitution there's a norm in the background that says obey the sentence that says obey the constitution there's always something outside the constitution that is doing a lot of the work. Do you think that your thinking on these let's call them explicit norms and implicit norms plays a role in how you think about central bank governance and whether it is or should be different in the US and the UK?

[00:05:56]>> I think the argument for an independent monetary authority in the United States, the UK, Germany, France is essentially the same. It's to do with separation of powers. that a an absolutely fundamental tenant of our shared system of government is that taxation should be um decided, approved, whatever in the elected assembly. That's the first step.

[00:06:22]The second step is the monetary levers are always and unavoidably so inherently implicitly levers of taxation either by unleashing surprise inflation or surprise deflation or actually even up to a point with expected inflation as well. But since the monetary instrument is an instrument latently an instrument of taxation the last people that should control it is the head of the executive branch is the king. So third point to make is that for hundreds of years in basically during modernity legislatures solved this problem via the gold standard. After that after we're off a commodity standard well then what's there to do? So you could have a committee of the legislature do it but that's actually not practically feasible because it's quite a time consuming task monetary policy and legislators have other things to do. Delegating to a central bank emerges as the solution of the following four. It is a delegation to a creature of the legislature.

[00:07:25]And now this creature of the legislature, the central bank has this kind of instrument that latently is an instrument of taxation. And so the legislature must put constraints on it so that it's not abused in that way. But to go back to the second step in the argument for the executive to take control really is to usurp the the authority of the executive legislature.

[00:07:50]I once said this to some um US constitutional scholars and they said no no but the but the president would still have to go back um to Congress to get spending approval. And I looked at them I mean I'm going to exaggerate this only a little. Um I looked at them in bewilderment. You think if you've got the money, you need to go and get approval for spending that relies on the norm of doing that. Well, if that norm was holding, so would the norm hold that the president shouldn't be controlling monetary policy. Actually, that conversation with those constitutional scholars was an interesting illustration of constitutional scholars not frequently enough thinking there must be something going on outside the constitution itself, a set of norms.

[00:08:34]Tell me if I'm wrong, but in the UK the prime minister sends a letter called a mandate letter every year or so in which defines clearly the macro objectives. Of course, you have a general mandate, but they actually they specify 2% inflation versus in the United States there is a dual mandate of the Fed, but in fact, what represent price stability is defined by the Fed itself is not determined by the executives. In primary legislation, the objective is laid down by parliament and it's lexographic.

[00:09:07]Achieve price stability and subject to that do things that will support the don't cut across the economic policies of the government of the day. And then the legislation says we parliament delegate to the executive treasury the power to flesh out what price stability means. and it should do so via a remmit that it gives to the monetary policy committee of the bank of England. One difference from the US is in the US the primary legislation sets the Federal Reserve essentially a dual mandate. But the UK thing is achieve price stability and subject to that do business cycle stabilization. In the US it's achieve price stability and do business cycle stabilization and trade off one against the other to the extent you need to. So the second part of this, there are more things to be said, but the second part of your question that I'm going to pick up on is so the Federal Reserve decides its own target. Do I think that's good?

[00:10:08]No. I doubt whether the legislature would want to delegate to the executive branch power to set Fed objectives. And if it did and the exe if it did make that delegation and if some executive eventually abused that power because Congress tends to be splerotic, it would find it very difficult to undo it.

[00:10:28]Whereas that, you know, a parliament undoing an executive in London is not very difficult. I don't think it's in feasible, but I think it's unlikely Congress would ever delegate to the executive branch a power to set the remitt. But I think the Federal Reserve could have done more to socialize its remit review with Congress and [clears throat] with the executive. And I think it should prioritize going to Congress given that on my argument and I think my argument is the true argument it is a creature of Congress and I think the Federal Reserve over a very long time has tended to be somewhat wary in its relations with Congress and I think that's a mistake. Ben, does thinking about this through the lens of the Fed in particular, although I suppose the same could apply to the central bank, but with less less leniency, is the Fed's short-term goals to preserve its own independence perhaps at odds with what would ensure its long-term survivability in its current form? In other words, if you think of the Fed as an independent entity with life of its own, are are short-term goals and its long-term goals congruent? It shouldn't have a goal of preserving its own independence on my view. There's also a tactical issue here. We haven't touched on this yet, but of course there really are important welfare arguments for having an independent central bank. It's not just a constitutional argument where Fed independence repealed today. long bond yields would go up, I think quite a lot, and the currency would fall and probably equities would fall and the rise in interest rates on average in the future would hurt people and the rise in inflation expectations and then eventually um the rise in inflation or the deep recession to avoid the rise in inflation expectations would hurt people and actually quite quickly people would say, "Well, actually, an independent central bank is quite a good thing, isn't it?" But that being the case, if I'm right about if you like the violence of the of the reaction to a loss of independence, then a central bank doesn't have to defend its independence too much. It just has to do its job well. This is quite unlike other areas of independence. If you if you stripped independence away from some other bodies, it might be harmful in the long run. might might not be but might be harmful in the long run but people would only discover in the medium to long run if Federal Reserve independence was was broken as we are speaking the costs of it will be apparent by tea time and that's a hell of a thing and I I think for reasons of of principle central bankers should not strive too hard to defend their independence they should explain the utility of the independence but not strive to defend it But it also shows why they probably don't need to to defend it. They don't need to protest too much.

[00:13:22]>> What is your view on the power of the executive actually to remove the chairman of the Fed or the chairman of the central bank? So I I'm not asking you a legal question the United States because I know you're not a legal schol.

[00:13:35]I'm saying from a sort of theoretical point of view. So, so for example, if a chairman of the Fed is doing terribly on inflation, can a president should a president be able to remove it?

[00:13:49]>> Let me come to your question in just a moment. It's a very important one, but there was a little qualification that you made. I'm not asking you the legal question you said because you're not a lawyer. This is a very American thing in the in the UK. Of course, trained lawyers are given great weight in these views and formally they're given the greatest weight because they make the final decision. But it's not assumed that others can't have a view on the law. Indeed, it the problem with the American way of thinking about this is that it kind of implies that the only body that is responsible for maintaining the Constitution is the Supreme Court whereas actually it's the duty of everybody. And that's not cheap shot against the United States. I think this is a slight problem. The number of times people say to me, "Oh, you know, we're not lawyers." And then they'll go on to discuss just the economics of it. And it means that people, Luigi, in your profession, haven't thought enough outside of Kidland and Prescuit and Barrow and Gordon about what central bank independence is. But to your question, which is an important one, there are three indices of independence.

[00:14:55]So this is a positive comment, not a normative comment. They are first of all that the executive branch should not be able to issue a direction that says oh by the way you've got a an interest rate meeting today set the interest rate at some number that's the first no directions. So the second is can't sack the central bank's policy makers not just the chair but the others as well because if you could well that would be a route to undermining the first and the third one is some budgetary autonomy. If you have to go to the legislature for your money frequently once once a year you will turn out not to be independent.

[00:15:38]I think were a president, any president, um, a widely popular president to sack a Fed chair for no reasons, well then that would diminish confidence in the independence of the of the Federal Reserve and it would diminish confidence in the um the credibility of its commitment to keep inflation low. And let's be clear, in those circumstances, it would be more difficult to stabilize the business cycle. Something that isn't said enough about the period after the global financial crisis, and I mean in the first 2 or 3 or 4 years. I'm going to make an assertion, but I think it's an assertion that many people would agree with. Had central banks not been independent in two late 2008 2009 when interest rates were being cut sharply and QE was being introduced, it seems to me extremely unlikely that an elected government would have been able to provide that amount of monetary stimulus cuz what would have happened is that long bond yields would have risen because people would have thought they were going to abuse their capacity to do to do that. I mean, I say this because there's there are there are people on the political spectrum that that think that central banks are a kind of part of a neoliberal kind of program or even conspiracy. And I don't think that I think that the people that that care most about jobs and kind of marginalize the poor in our societies, the capacity of the central bank to provide overwhelming monetary support in dire circumstances without people losing confidence in price stability is an extraordinary and an extraordinary valuable thing that we did not revisit.

[00:17:24]I mean, it's been it's been pretty terrible since the global financial crisis in in lots of ways, don't get me wrong, but we did not revisit the Great Depression. And the reasons for that are, I think, to do with lessons learned from that period about the design of monetary policy institutions and the conduct, the policym of monetary policy institutions. But then I see that point of view that you just expressed as being a bit at odds with the idea that the central bank should be more constrained because what the central bank did in the financial crisis and then again in the pandemic was to stretch the limits of its remitt in ways that elected officials did not entirely understand they were they were doing at the time.

[00:18:08]And so how do those two things square together? If you want the central bank to have the power to do that, but at the same time, a central bank with unconstrained power is not a a great thing. How do those things fit together?

[00:18:20]>> Okay, I see the I see the point of the question, but I don't think I wholly agree with it. So, first of all, maintaining monetary stability, price stability isn't just about inflation.

[00:18:30]It's about avoiding deflation as well.

[00:18:32]The implosion of the banking system was destroying um money. What central banks did is offset a collapse in broad money with some more narrow money. Now you then make the point but did they do things that were kind of stretching their boundaries to do so? There are two things here. Were they stretching the boundaries in law and were they stretching the boundaries in terms of a general understanding of how monetary policy can be conducted? Let me start with the with the UK. We were quite clear and everybody else is quite clear that the Bank of England had the authority to buy government bonds. It had been doing so for a few hundred years and nor did we think it was hugely unconventional. In the 1980s, in a period that was called overfunding, but we shouldn't get too distracted by this.

[00:19:21]The government and the Bank of England overissued government bonds so as to depress the pace of increase in broad money. This was during the period of monetism which was largely mad. It was called over um funding. And Mvin King and I said to each other, well, what we're going to do with QE, it's underfunding. But had it been used before in quite that way? No. So, we did two things. We talked openly to Parliament about it. And before that we agreed there was an exchange of letters between the governor of the bank and the treasury secretary or as we call that office the chancellor of the excheer which had two things in it. First of all that they would indemnify the bank of England against losses and get the profits but that was merely a way of publicizing what was true anyway and is true here. And the second thing that was part of that exchange of letters, they would not change their government debt management strategy to um partly undo the effects of QE. In other words, if we were buying long-term bonds, they wouldn't issue more long-term bonds and they agreed with that. So, the details don't matter. What's behind that is a thought this is perfectly within our vare. Um it's unfamiliar in a world where parliament tells the treasury to set a remmit. We need an instant exchange of letters with the treasury which we had. I was part of the the governor was talked to me a number of times the weekend when he was discussing that with Gordon Brown last um darling.

[00:21:00]um that was then incorporated into the next annual update of the remitt and actually during the during the financial crisis I think not in around QE there was an agreed a mini accord between the US Treasury and the Federal Reserve about the use of its balance sheet during that period as far as I know um that has not been updated and I think it should have been I think co is completely different actually co is kind of a misuse of powers rather than an abuse of powers and by that I I mean, the Biden administration makes a huge fiscal injection and the Federal Reserve carries on adding stimulus at the same pace it would do otherwise. Well, I mean, this is absolutely extraordinary that the the shock that comes both requires the Biden stimulus and requires the Federal Reserve to carry on as though nothing's happened. So, there must be a shock that precisely lands it on that. I think the criticisms during that period of the B Biden fiscal stimulus were misdirected. They should have been directed at the Fed. And I think the Biden administration's attacks on the people criticizing its fiscal stimulus were misdirected. They should have just said, well, the macroeconomic implications of this are for the Federal Reserve. But this came during a period where um and I don't enjoy saying this um but it was a big change. a Treasury Secretary had got used to talking about monetary policy and the conduct of monetary policy. And if you go back to the 1990s, that that didn't didn't happen. I was what you would call chief of staff to the governor of the Bank of England in the late ' 80s, early '9s, and so have been watching these things for a long time. And it was quite novel to have a Treasury Secretary fantastically expert in monetary policy as it happens, offering a commentary on on monetary policy. And I think you know these I don't really understand what an Overton window is but to the extent that I've got a little grasp of it these little things shift the over O over O over O over O over O over O over O over O over O over O overton window. If central bank independence is meaningful then this isn't just as I said earlier the central bank shouldn't go around being neurotic about its independence.

[00:23:07]Um but so everybody else in government holding positions of great power needs to conduct themselves in recognition of that independence and unless they wish to weaken it. During the same period talking about inclusive growth was a mistake. It's not a mistake because inclusive growth doesn't matter. I mean it plainly does matter. It's a mistake because central banks don't have an instrument for generating inclusive growth, only aggregate short-term demand growth. If they were to give an instruments to affect distributional issues, I think the response of many people including me would be, "Hold on.

[00:23:47]Isn't that why we elect people?" But in the United States, it seems that the the chairman of the Fed does not really pay for his mistakes because you said that Powell made a big mistake in 2021 with the inflation of the stimulus and then in 2023 there was a major banking crisis that was a failure in supervision. But we have not seen any accountability on any of the two counts. In fact, after the first, he was renewed as chairman of the Fed and after the second, nobody except maybe me blame him for that. And it seems like almost in polite circles, you cannot raise criticism of the chairman of the Fed.

[00:24:26]>> I don't think this is to do with polite circles. I do think it is a big issue and I think you are basically right. But it goes back to the question about remitt which I'll come back to if I may.

[00:24:36]I'd like to start with the supervision.

[00:24:38]So this was the failure of SVB alongside other large regional banks had been exempted from various supervisory and regulatory requirements including resolution planning and when they were consulting on whether to do this the Federal Reserve and as it happened as the FDIC had been told by various people that this would be a mistake and could lead to wholesale deposit run on the regional banks and if it did because there were others that had similar liability structures they could be a degree of contagion. I know that because I was chair of something called the systemic risk council at the time which included Paul Vulkar and John Clichrice and I signed a letter and Sheila Bear a former chair of the FDIC and many others. I I signed the letter from the SIC that effectively said that but we weren't the only ones who said it. The then vice chair of the FDIC said it in a speech in in Washington and they went ahead and I do think it matters that there has been very little debate about that. I think it's probably the most egregious supervisory set of mistakes that I can remember pretty well anywhere that affect stability. So the problem is here is that if you if you sack the person or they resign after testifying to Congress or to the parliament, well then you start to undermine independence. And I think the remedy actually is to tweak the regime to require more transparency to to realize I I think in the in the US's case I think in the wake of the postcoid mistakes I think the stance from Congress should have been well you can't be left entirely free to make these regime changes of the kind that you made and we are going to put some constraints around your regime reviews in the future. And then of course you get to the problem to the extent that Congress tried to do that in law it would a tie itself up in knots while it was trying to do so and if it wrote wrote a law that wasn't terribly good it would find it horribly difficult to amend it which is very different from a parliamentary system and so I think all I think the point about accountability can't quite be about the individuals unless the individuals have been egregiously kind of negligent or or whatever, but I think has to be about how can how can we the American people within and their elected representatives within our system of government set up something that is a little bit more flexible to ensure proper congressional oversight and constraints around the Federal Reserve. I have a a simple very simple proposal that every time the chairman of the Fed invokes the systemic exceptions in which they expand the deposit insurance. He should tender his resignation at the same time because to some extent you arrive at the crisis because of lack of proper regulation exampic exception. So the systemic exception comes with the resignation of the chairman >> I think. So I haven't thought about that and I'm not going to think about it out loud. Now I have thought about something else which is in the same ballpark because there's accountability of the Federal Reserve in the circumstances you're describing and there's the accountability of bankers and non-bankers that end up getting emergency help. So I would prefer a system where everybody that runs these large maturity mismatches has to sign up for the discount window. And if ever there are circumstances where somebody hasn't signed up for the discount window but needs to use it and the government and the Fed decide together that they should use it then all the bosses of the firm concerned should be banished from financial commerce for the rest of their biological lives. So one last question.

[00:28:32]Suppose you were king of a day for a day, the king of America for a day. What would you change in the institutional structure of the Fed to make it more legitimate?

[00:28:44]>> I don't think one should have a king for a day. Certainly my country doesn't have a king for a day or it hasn't had since the early 17th century.

[00:28:51]>> Your prime ministers for day for a day.

[00:28:54][laughter] >> Uh well he he or she would have to go to parliament. Even Mrs. Thatcher had to go to parliament and Mr. Blair too. I think the chairs of the Fed should get around the country more and be more visible around the the country. And whenever I've said this to Fed people, they say we have regional Fed presidents that do that. And I don't think that's enough. I think I think the people of America are entitled to see the most powerful person in the Federal Reserve in their neck of the of the country. And I think the chair of the Federal Reserve, and this has been changing a bit, should be on television a bit more. I mean, governors of the Bank of England go on television.

[00:29:33]There were used to be, and I'm sure there still is, a strong norm that no, but don't compete with the politicians.

[00:29:39]And that's a fuzzy line that it's possible to cross and it's important not to cross. But the people need to know who you are, particularly the the the number one office holder because when things going wrong go horribly wrong they well who is this person and yet at the same time I believe that in the big crisis the presidents should front up more these things are not inconsistent.

[00:30:04]Can I say one final thing Luigi that you haven't asked and I thought you might.

[00:30:09]There are some people around the place who are saying well Fed independence for monetary policy has to be maintained but it should really be taken out of regulation and supervision. The Federal Reserve is inalienably the lender of last resort. This is anything to create another central bank and it will be the inalienable lender of last resort. You do not want a lender of last resort that doesn't know anything about banks.

[00:30:35]The UK tried that. Supervision and regulation were taken away in 1997.

[00:30:41]And I want to choose my words carefully.

[00:30:46]Parts of the of the Bank of England struggled during 2007 in ways that were probably harmful to the country and the world. And I think it would be a terrible terrible thing for the American people and in fact for the world for the US to to try that experiment. I mean I think this trope of when you talk about democracy is an experiment. I mean get over it. You've had it for um nearly 250 years. Um, now whereas taking supervision out of the Federal Reserve and a regulatory role would be an experiment and it would end in it would end in tears and it would end in more fiscal bailouts. And the people on the libertarian right, it's not only them that argue for for this stripping of the regulatory supervisory role, the banking role away from the Fed, that they would hate the eventual outcome even more than they dislike the current state of affairs. Which is not to say that there aren't really big improvements to be made on that side of the Federal Reserve, and we have touched on some of them in in this conversation. But the final thing to say, if I may, Luigi, is that financial stability is now part of national security. The great winners from the global financial crisis are based in Beijing. It was a confidence boosting moment for them. It enhanced their reach around the world, partly because the western capitals were distracted, partly because then the western system was discredited. The last thing, those of us that are deeply committed to liberal democracy, constitutional democracy, a democratic republic, whatever the three synonyms, the last thing we need is another grave financial crisis. It is insufficiently understood that the Federal Reserve headquarters is actually an important element of United States leadership in the in the world. And I really don't think enough people in Washington appreciate how important the Federal Reserve is, how important Federal Reserve credibility is to the credibility of the dollar. I think debates about Fed independence should be seen in that context. And I do not have great confidence that this the the Supreme Court will be able to find its way through all of this in a in a sufficiently principled way.

[00:33:11]>> [music] >> If you're enjoying the discussions we're having on this program, there's another University of Chicago [music] Podcast Network show you should check out. It's called The Pie. Economists are always talking about the pie, how it grows and shrinks, how it's sliced, [music] and who gets the biggest share. Join veteran NPR host Tess Vigland [music] as she talks with leading economists about their cutting edge research and the key events of the day. here. How the economic pie is at the heart of issues like the aftermath of a global pandemic, jobs, [music] energy policy, and so much more.

[00:33:49]So, Luigi, the really new thing that I learned is that among economists actually this idea of how free the Fed is from political influence has been debated for a long time and the door is opening on that more and more. But the point you made about the Fed not being free from influence from Wall Street, I haven't seen studied by economists. Has that been as well? And I guess what do you think of that first point?

[00:34:14]>> I don't think that there's much interest in economists discussing about the capture by Wall Street in part because it's admitting that they themselves are captured. when I at least raised the fact that somebody like Janet Yellen who is a wonderful economist and I think was a good chairman of the Fed or chairwoman of the Fed and and a good secretary of treasury but thanks to the fact that she was appointed to the Treasury shortly after she was at the Fed. We learned that she earned $8 million giving speeches in the year following her position as a chairwoman of the Fed.

[00:34:50]There is not nothing wrong about giving speeches being paid for speeches. The question that I raise, imagine she had a very aggressive policy that for example did not bail out banks in Wall Street.

[00:35:06]Would she be so welcome in giving speeches at Wall Street? And if the answer is no, I find it defying gravity that an economist can think that this potential reward on the margin wouldn't affect her decision. And and I don't want to pick on Jalant Yellen. I'm just saying any economist, but the only reason why we use Jalen is because we have a disclosure how much she made.

[00:35:30]Okay. My definition of an economy is some somebody that think that $8 million on the margin should affect decisions because you believe that money and and incentives matter. If you are a doctor, you're free to think whatever you want.

[00:35:43]But if you're an economist, I think you're bound to believe that. But most of my colleagues don't believe that. So that's the perplexing part.

[00:35:51]>> That's really interesting. Certainly anecdotally that does make some sense of what we've seen from the Fed in the decades since I've been covering the markets because certainly we saw it from Greenspan's Fed and we saw that through presidents with whom he was not aligned politically and I think we've seen it from every Fed chairman since then. By which I mean an adherence to to Wall Street. It's not just that they stand to make money from giving speeches or from being close to Wall Street or have better career opportunities after they leave leave the Fed. It's that so much of the health of our economy rests on the stock market now that they almost are victims to the success of of of the stock market or captives of the success of the stock market. No Fed chairman wants to be the person who cratered the stock market and therefore caused another depression of our financialized economy. And so I think our very reliance on a financialized economy has also created that dependency.

[00:36:46]>> But this is much more recent phenomenon.

[00:36:48]The dependence on Wall Street. I think the dependence on Wall Street goes back to Greenspan even before so many depended on the stock market for their retirement but certainly that only accumulated or increased the importance of that. But the other part that we don't want to forget is that the Fed has an important role as a supervision authority. That's where the capture is more dangerous because you are afraid to really to use a technical term piss off people in Wall Street as a result. Not to mention that after 2008 there was a reform but before you had the presidents of the various feds were elected by or appointed by a board that included all the major bankers. He says it's still the case that is the board but they don't have the voting power in the decision the decision to elect a board chairman of the various feds. So in the New York Fed you have the JP Morgan CEO and various other people on the board of the Fed. So speaking of the influence you are you are making those Fed officials independent from politicians but talking to business people. And what kind of business people every board meeting? Have you ever heard the term greenhouse effect for Supreme Court justices?

[00:38:08]>> No, I haven't.

[00:38:09]>> Oh, you love that. Actually, it's coming from a journalist, Linda Greenhouse, that was uh specialized in treating the Supreme Court. And people were saying that in the past the Supreme Court was drifting left when they were going to Washington. And why? Because they were living in Washington and were constantly harassed by Linda Greenhouse with their articles. And so they were moving left as a result of the social pressure. And I can tell you that in Europe, the fact that the central bank of Europe is in Frankfurt and is not in Paris or God forbid Rome changes dramatically the environment because the pressure that they receive is from the German press and the German environment rather than being the French press or the French environment or the Italian press and Italian environment. So the fact that the Fed at least the president of the local Feds are embedded in the business environment plays a huge role.

[00:39:05]>> Yeah. And I guess one other way to measure the Fed's power and its hold in some ways on our economy is that even though one of the largest institutions to fail in the financial crisis was Croup, a regulated bank, and certainly a lot of the problems came out of the regulated banking sector and out of Wall Street, which even though at that time was regulated by the SEC, the Fed also was in there talking to people all the time. The Fed still somehow managed to emerge from the financial crisis with more power rather than less power.

[00:39:33]unlike many other regulatory authorities. So, I think some of that shows that it's kind of a two-way street. There's also the Fed may be captive to Wall Street, but there's very little incentive anywhere to anger the Fed either.

[00:39:46]>> Yeah, you said correctly. Not only with more power, but with impeccable reputation because the Fed did do a lot to rescue the situation after the facts, but honestly did nothing to prevent the facts.

[00:39:59]>> Right. Right. [clears throat] Right. It was a situation in part caused by the Fed and and and so when we when the Fed gets all the the credit for being the hero in that situation. I've always thought it was interesting that that was the way that the the narrative told and was told and there was a lot of effort to blame the SEC and I think it was because blaming the SEC detracted from any blame that could occur to the Fed and it was interesting it was on the part of a lot of economists who were over overly eager to blame the SEC for the financial crisis because that way they could say the Fed was perfect.

[00:40:30]Anyway, we digress a little bit.

[00:40:31]>> No, no, but wait, wait a second. You actually made me think one thing.

[00:40:35]Remember Tim Gner, who was first at the Fed and then the Treasury, was very fun to say when there is a fire, you have to put out the fire. You don't have to look for the arsonist. And [laughter] of course, I'm exaggerating a bit, but if you are the arsonist, the last thing you want is to look for the arsonist. Right.

[00:40:53][laughter] >> That is true. What did did Tucker have a clear sense to you of what we in the US should do, what it is we're getting wrong, and what would be a better way forward?

[00:41:03]>> Yes. My reading of what he said is that he does believe that Congress should play a more active role in in mandating and specifying the goal the Fed should follow, but certainly does not want the president to be so influential in monetary policy. So it's an interesting kind of nuance because most of the people who opposed Trump on that dimension are people who want a total independence of the Fed from anything.

[00:41:32]While Paul Tucker recognizes the importance of having a political mandate for the Fed because the Fed shouldn't basically go on its own in part because might be captured by Wall Street but in general if the Fed is too much seen as a technocratic institution. It eventually will lose political support and the backlash would be even worse. And so what he thinks is that there should be a very clear mandate from Congress on what to do and then leave the Fed independent on how to do it.

[00:42:05]>> Yeah, I thought his point about how this situation allows elected officials to duck their responsibility is really really interesting because this fig leaf of independence also allows politicians to say, "Oh, it's the Fed." As if they have no control over it. And given the importance of monetary policy in our rule in our world that is a derelction of duty in a sense on the part of elected politicians right the ability to say that this really important thing is happening but not my fault not my problem I I don't have any control over it whereas in reality probably exerting control through back channels and you'd rather just have it be explicit.

[00:42:44]So Luigi, what was the first thought that went across your mind when you saw the news that the Federal Reserve had been subpoenaed?

[00:42:53]>> That uh we went down one step in how banana republic the United States is becoming. I refuse to think that this is just about interest rates because either Trump is stupid and I don't think he's stupid or is something about much bigger than interest rate. If you wanted interest rate uh lower, there were a more subtle way to nudge the Fed to do that by using the sledgehammer. He all but ensure that the next meeting will not cut interest rate because you you have to prove the opposite. So why is he doing this? He's doing that to prove that he has absolute power. This is a power grab move to scare everybody in a sense. We are worse than the Soviet Union because you can be attacked, criminally attacked, criminally indicted for resisting to Trump. That's basically the message. The impact that this has through the institutions, through firms is enormous. I I just heard that a bunch of firms were afraid to show up at an academic seminar about immigration because the journalists were there. And why is because they don't want to say in public that they are in favor of more immigration because they are afraid of Trump retaliation. So I think that this is not just an attack to fed independence is an attack to the integrity of the US system. Maybe in this case, Trump has finally gone too far and that there is going to be and you're already seeing some signs of that there is push back against this in broadly speaking in a way that some of his previous actions have not registered. And I think it's because people do recognize how much all of this matters. you decrease faith in the Federal Reserve, the cost of American debt goes up, the dollar goes goes down and that ends up impacting all of us in a way that is really devastating.

[00:44:52]>> Yeah. But look at it. You did not see the market collapse. You didn't see a lot of people revoling. Yeah. You had like central bankers writing a letter etc. But this is within a small group of uh intellectual elite. Imagine a second in which you had President Obama doing something like this. I think you would have seen part of the conservative down the street in with guns uh to say that this is a takeover. We need to protect America. We need to do this. You need to do that. In the grand scheme of things, I think that uh I don't want to say this one under silence, but it it's not as dramatic as uh it should be.

[00:45:35]>> That does beg a question. Why do you think the market didn't react more?

[00:45:39]>> I think because at the end of the day they think they are going to get from Trump more than Trump is going to cost them is a very sort of a cynical calculation. But all this idea that the market protects institutions etc etc. No, the market protects the brands of the shareholders. If the shareholders expect to receive more then it's going to cost them. They're going to sort of uh be happy.

[00:46:05]>> Okay. Okay. Well, that's an argument though for the US stock market and I might agree with that. But what about the lack of reaction in terms of global investors to US debt or the dollar? Why has the reaction not been more pronounced? I mean, you would have thought that if something like this had happened that interest rates would spike and the dollar would plunge. And I think there was there was some reaction. I actually need to check this, but but not as much as one might have expected. You know, this is the big advantage of a monopolist. When uh you had a leak in some of the credit rating agency, no, sorry, credit scoring agencies like TransUnion, etc., you saw the market price go down a little bit, but don't go back up right away. Why? Because you have no alternative. They have such market power that you can't go anywhere else. And I think that the same is true with the US dollar and the US Treasury.

[00:47:00]The US dollar is the international medium of exchange and is very difficult for anybody to go anywhere else and at the end of the day if you want to save assets you're going to invest in US Treasury. What is the alternative?

[00:47:13]>> So in that sense does the lack of reaction say as much about the state of affairs around the globe as it does about what's happening in the US?

[00:47:21]>> Absolutely. And I think that President Trump can get away precisely because there is this this vacuum this uncertainty at the moment. this needs for US dollars. This is dangerous because it doesn't create a sufficient push back to stop this deterioration.

[00:47:38]We're going to wake up a moment with a country with much much weaker institutions and going back is much more difficult.

[00:47:47]>> I wanted to ask that. Is there any historical analogy? You're obviously an expert on much of this including on on Italy. Is there any historical analogy that would argue that the lack of an immediate reaction doesn't mean a slow degradation?

[00:48:02]>> Oh, absolutely. In the sense that historically the markets were seen as a way to provide an immediate feedback for something that has long-term consequences. In many institutional choices, we don't have a market that immediately give a a feedback. And that's a problem because you don't pay the immediate cost for stuff that in the long term is very negative. This monopoly situation of the US in the world weakens this this reaction and and also this prospect of great wishes through some AI boom is uh anesthesizing even the stock market. So we lack a powerful response to institutional degradation. So, is then there a larger conversation here about the lack of market response and and how problematic that is? And is there a time in history where the market also hasn't responded?

[00:48:58]And maybe I think actually I don't know, but maybe the advent of World War II might be one of those times where the market didn't tell us immediately that and I'm not sure about this. I I wonder actually it would be really interesting to look at gigantic worldchanging events and whether the market reaction actually was a predictor of of the importance of something and that does in a really fascinating way challenge this idea that the market is a barometer of what's happening in the world.

[00:49:26]>> I think that the the market is very good at measuring small things is not very good at interpreting catastrophic changes. I had a student who did this very interesting dissertation about the nuclear risk during the cold war and the market was pretty good at interpreting this uh nuclear risk in a cross-sectional variation. So Cuban missile crisis exploded for example the market went down. Interestingly, places that were located next to nuclear missiles where the Soviets will attack first or companies located there went down more than companies located away from there. So as as you know New York was one of the major point of attack but also there were some places in whatever Dakota where the United States stole some uh important nuclear capability and they would be obliterated by a nuclear war. So what is interesting is that after the end of the cold war they release all the estimates they had of a nuclear war and at the time it would not have wiped out humankind only killed like half of it or something like that but the remaining half would have been alive. So now the point is that the market was very good at the cross-section but was missing completely the risk. the market went down I think 5% that day when the probability of a nuclear war was substantial and the the actually ultimate killer for me are the fact that the market did not get it right if you have an enormous probability of dying tomorrow but then if you don't die tomorrow then is business as usual you should see a very funny ill curve right because the interest rate between today and tomorrow you want to drink more champagne If I know I'm going to die tomorrow, I'm going to sell some of my bonds and drink more champagne.

[00:51:20]>> Good champagne. [laughter] Yes, definitely. Of course, h the most expensive champagne. So, you should see kind of a very high yield in the short term and then going back up to normal after that. None of that took place during the Cuban missile crisis. So the point is the market is not very good at making dramatic forecast where you don't really have a good scenario and it says what will happen after a nuclear war god only knows right would the US bond market still function will electricity still function what what are the things we like the most under that situation these are kind of really really difficult question and I don't think that the the market takes those possibility very seriously until it's probably too late.

[00:52:09]>> That's actually fair fairly dismaying in terms of the wisdom of the crowd being reflected through the markets and also in terms of just how sanguin we should be about current events given the lack of market reaction. In other words, if you are inclined to take comfort in the lack of market reaction and say, "All right, well, maybe this is okay. It actually doesn't really mean anything at all."

[00:52:29]>> I'm sorry to say you're right.

[00:52:31][laughter] I didn't want to be right.

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