In his column today, Ron Paul mentions that those who insist the Fed functions with “independence” tend to forget – or at least not mention – the numerous historical episodes in which the Fed did not exercise any such independence.
As an example, Paul mentions the time President Lyndon Johnson
summoned then-Fed Chairman William McChesney Martin to Johnson’s Texas ranch where Johnson shoved him against the wall. Physically assaulting the Fed chairman is probably a greater threat to Federal Reserve independence than questioning the Fed’s policies on Twitter.
For those unfamiliar with the episode, I thought it might be helpful to look at some of the historical context surrounding the situation.
In his book The Man Who Knew: The Life and Times of Alan Greenspan, Sebastian Mallaby writes:
Johnson had pushed Kennedy’s economic policies to their logical extreme. In 1964, he had delivered a powerful fiscal stimulus by signing tax cuts into laws, and he had proceeded to bully the Federal Reserve to keep interest rates as low as possible. When the Fed made a show of resistance [in 1965], Johnson summoned William McChesney Martin, the Fed chairman, to his Texas ranch and physically showed him around his living room, yelling in his face, “Boys are dying in Vietnam, and Bill Martin doesn’t care.”
This was the 1960s version of “you’re either with me or you’re with the terrorists.“
Of course, Johnson didn’t stop at pushing around a central banker. Mallaby continues:
If the tax cuts and low interest rates caused inflationary pressure, Johnson believed he could deal with it with more bullying and manipulation. When aluminum makers raised prices in 1965, Johnson ordered up sales from the government’s strategic stockpile to push prices back down again. When copper companies raised prices, he fought by restricting exports of the metal and scrapping tariffs so as to usher in more imports. The president battled uppity prices for household appliances, paper cartons, newsprint, men’s underwear, women’s hosiery, glass containers, cellulose, and air conditioners; when egg prices rose in 1966, he had the surgeon general issue a warning on the hazards of cholesterol…”
In other words, Johnson was willing to apply pressure to the Fed through means other than making threats or engaging in physical assault. Johnson’s manipulation of prices through strategic stockpiles illustrated that Johnson used a wide array of fiscal and industrial policies to get his way. It’s entirely possible that in addition to demanding the Fed keep rates low, Johnson wanted to show Martin and other voting members at the Fed that Johnson had his own set of tools he could use to stimulate the economy as he saw fit. Politically speaking, Johnson might have been showing the Fed he could provide it political cover by helping to keep inflation low alongside the desired easy-money policy employed by the Fed. Of course, a good economist would point out that using such methods constitutes playing with fire. But there’s no reason to believe that Johnson was particularly interested in good economic theory. He was likely only interested in short-term political gains that might be had from manipulative fiscal policy.
For good measure, we might note that another account of the Johnson meeting — provided by Martin biographer Robert Bremner in Chairman of the Fed — is this:
In December 1965, President Lyndon Johnson was pacing in the office at his ranch in Johnson City, Texas, while he waited for William McChesney Martin Jr., the chairman of the Federal Reserve Board, to visit for what Johnson called “a trip to the woodshed.” Two days before, Martin had led the Fed’s board of governors to an increase in the Federal Reserve discount rate, the first in more than five years of uninterrupted economic growth. Through Henry “Joe” Fowler, his Treasury secretary, and Gardner Ackley, his Council of Economic Advisors (CEA) chairman, Johnson had advised Martin to delay the rate increase, and his instructions had been rejected. Few people ignored Lyndon Johnson’s instructions, and he was furious when he heard of the Fed’s move…
The meeting was a classic confrontation. Johnson was a powerful and manipulative president who believed that a Fed tightening would jeopardize the economic expansion and the tax revenues he needed to finance the most important goals of his presidency…
When Martin walked into the office, Johnson immediately accused him of placing himself above the presidency and totally disregarding Johnson’s wishes: “You went ahead and did something that I disapproved of … and can affect my entire term here.”
As if so often the case among defenders of Fed independence, Bremner writes, “Martin admitted later that he was shaken but determined to stick to his position and not to insult the president of the United States.”
The truth, however, is that it’s impossible to know how much Johnson’s political pressure influenced Martin’s actions. Of course, Martin is going to say he was not influenced in any way, and most commentators on the matter simply take Martin at his word. Credulous observers often assume that since the discount rate rose slightly in early 1966 that Martin “stood his ground.” But how much might the rate have increased without Johnson’s intervention? Indeed, the rate went down again in 1967, and it was only after it became clear that Johnson would not have a third term that we begin to see a significant rise in the discount rate.
Johnson announced he would not run for re-election in March 1968. The Fed’s discount rate then shot up from 4.66 percent in March to 5.5 percent two months later. The last time rates had increased so rapidly had been under the Eisenhower administration. Are we to believe this was just a coincidence? It’s possible, but there’s no reason passively accept the claim that Martin was not influenced by Johnson’s politicking.
Moreover, this sort of thing is impossible to measure, as political scientist Irwin Lester Morris has noted in Congress, The President, and the Federal Reserve. Looking at attempts by presidents to influence monetary policy — such as Johnson’s — Morris writes:
When do presidents achieve their monetary policy objectives? When they are personally convincing and domineering? Possibly, but how would one go about measuring these qualities?
The “qualities” of the political actors here, of course, include both the president and the Fed chair, as well as other voting members at the Fed.
It’s exceedingly difficult to say how much presidents influence these members, although it would be naïve to conclude presidents exercise no influence. After all, in other agencies and branches of the Federal government it is often assumed that efforts at exercising influence are effective — including efforts brought to bear on non-elected, non-partisan officials. Yet, we are to believe that the Fed is immune from all of this.
As a final note, it is also important to reject the assumption that pressures on the Fed always take the form of efforts to ensure an expansionist monetary policy. There is not actually any reliable empirical evidence for this assumption, as Morris notes in his survey of the research on the Fed and political pressure groups: “At least in the case of the Fed, the assumption that elected officials consistently favor inflationary monetary policies at the expense of price stability is unsubstantiated.”
Politicians are often just as fearful of inflation as they are of a slowdown in economic growth — at least historically — and politicians are not content to simply let the Fed do its own thing out of some vague devotion to “independence.” The Lyndon Johnson episode is just one illustration of this.