The Myth of Fed “Independence”

"Underneath, it’s all politics."

By Jonathan Newman, Mises Institute

One of the central myths of the modern Federal Reserve is that it is “independent.” The idea is that the Fed is squarely focused on its dual mandate from Congress and is not influenced by politics, presidents, or pressure from the Treasury to keep the government’s borrowing costs low. In a Q&A after his recent speech, Fed Chair Jerome Powell said:

“Generally speaking, Fed independence is very widely understood and supported in Washington, in Congress, where it really matters. The point is we can make our decisions and we will only make our decisions based on our best thinking, based on our best analysis of the data about what is the way to achieve our dual mandate goals, as best as we can to serve the American people. That’s the only thing we’re ever going to do. We’re never going to be influenced by any political pressure.”

This, of course, is plainly false. The Fed interprets the “price stability” part of its dual mandate to mean that it should target 2 percent annual price inflation as measured by various official statistics. Thus, the Fed by design feeds the political machine in DC by concealing the costs of government spending. The Fed serves the government, not the American people.

But Fed independence has its own mythical history. Fed historians point to the Treasury-Fed Accord of 1951 as the watershed event in which the Fed finally broke free from political pressure. They say that the Fed was sick and tired of maintaining low interest rates for the Treasury after World War II, and that the Fed dug in its heels during the Korean War, breaking free from the reins held by the Treasury.

The Official Narrative

The official narrative goes this way: During and after World War II, the Treasury pressured the Fed to peg interest rates at 0.375% for short-term debt and 2.5% for long-term debt. According to Jessie Romero’s essay on the Treasury-Fed Accord at federalreservehistory.org (a website maintained by the Fed), “The goal of the peg was to . . . allow the federal government to engage in cheaper debt financing.” The Fed had to buy a lot of government debt to keep rates low, and since the Fed buys debt with new money, it resulted in large increases in the money supply. Year-over-year price inflation as measured by the Consumer Price Index hit 17.6% in June 1947 and 21.0% in February 1951.

Romero continues: “With inflation on the rise, the FOMC [Federal Open Market Committee] felt strongly that the continuation of the peg would lead to excessive inflation. Throughout that year, the FOMC tried various tactics to raise short-term interest rates, but was successfully opposed by the Treasury.” After a series of meetings (some including President Truman himself) and public statements that reflected conflict between the Treasury and the Fed, “the Fed informed the Treasury that as of February 19, 1951, it would no longer ‘maintain the existing situation.’”

The famous accord was reached in a meeting in early March 1951. The Treasury secretary, John Snyder, was in the hospital, so the assistant secretary, William McChesney Martin Jr., represented the Treasury. The Fed was represented by Winfield Riefler, Robert Rouse, and Woodlief Thomas. Romero says they “negotiated a compromise” and released a public statement saying they had reached “full accord with respect to debt management and monetary policies.”

Romero concludes:

“At the time, it was not known how profound an effect that statement would have. But the accord marked the start of the development of a strong free market in government securities, which continues today. . . . But most important, by establishing the central bank’s independence from fiscal concerns, the accord set the stage for the development of modern monetary policy.”

Plot Holes

One important plot hole in the official narrative is that none of the advocates for Fed independence were at the pivotal meeting in March 1951. Marriner Eccles, who was Fed chair from 1934 until Truman declined to reappoint him in 1948, had made public statements in favor of Fed independence. This was a reversal for him, since he was happy to finance government deficits during the Great Depression and World War II. I suspect that at least one motivation for Eccles’s reversal is that he had personal animosity toward Truman. Eccles remained on the Fed’s board of governors after Truman appointed Thomas McCabe as Fed chair in 1948.

Thomas McCabe was also a public supporter of Fed independence, but he was not at the famous meeting. McCabe was a key player in the drama: he was the one who announced that the Fed was “no longer willing to maintain the existing situation.” Fed meeting minutes show, however, that McCabe did not represent a consensus view among Fed officials—maybe not even a majority view. This is backed up by a February 8, 1951, announcement from Truman after a meeting with Fed officials that “a majority of the Reserve Board members” had sided with him.

The picture we get is that McCabe and Eccles were lonely advocates of Fed independence. They might have had a few on their side within the Fed, but the fact that neither one of them represented the Fed in the Treasury-Fed Accord should make us question whether Fed independence was really on the table at the meeting. There’s no indication that those who did represent the Fed (Rouse, Thomas, and Riefler) were on the side of Fed independence. In fact, there’s more evidence that they were on the opposite side: Riefler championed the way the entire US economy was nationalized for the World War II effort; and Rouse had previously reacquired the Fed’s repurchase agreement authority, which was the primary way the Fed had helped the government finance World War I.

What Happened at the Accord?

The meeting itself is a bit of a mystery. While both the Treasury and the Fed released statements saying that there was now “full accord,” the details are hazy. The Fed agreed to certain temporary rate pegs and the Treasury agreed to replace their 2.50% marketable bonds with 2.75% nonmarketable bonds (meaning the Fed wouldn’t have to buy them). Other accounts explain that “the Fed promised to raise its discount rate only with the Treasury’s permission, which was unlikely to be given except under ‘very compelling circumstances.’”

In a congressional hearing after the accord, Senator Paul Douglas pried for details. The following exchanges are documented in A. Jerome Clifford’s 1965 book, The Independence of the Federal Reserve System (published by the University of Pennsylvania Press). Allan Sproul, the president of the Federal Reserve Bank of New York, said:

“As I say, I do not like the implication which one of your witnesses left that this was a battle that the Federal Reserve won, and while it may have won a battle, that the Government always wins the wars. I say there is no battle between the Government and the central bank. It was a conflict, a difference of opinion, between the Treasury and the Federal Reserve System, both of them representing the Government, and you can call it a triumph of reason, if you want to, but not the winning of a battle.”

And then when Douglas questioned Treasury Secretary Snyder, this exchange took place:

“Douglas: Who is to determine the interest rate?

“Snyder: Well, that matter is always discussed very carefully, sir.

“Douglas: Who is to make the final decision on it?

“Snyder: There is only one place that it can finally be made by law, and that is in the Treasury Department.

“Douglas: When the Treasury makes the decision, therefore, is the Federal Reserve Board supposed to purchase a sufficient number of bonds so that the issue can be a success at the interest rates determined by the Treasury?

“Snyder: I think we can work out cooperation.

“Douglas: Cooperation is a beautiful word, but it is like an overcoat, it covers quite a range of reality.”

Indeed, Treasury and Fed officials frequently used “cooperation” and “coordination” after the accord, almost like a group of criminals who had agreed on a common story before talking to the police.

Douglas asked William McChesney Martin Jr., who had just been appointed Fed chair, how the Fed and the Treasury would deal with a “conflict of wills,” to which Martin responded: “All I can say at the moment is we would sit around the table and hammer it out.”

The Outcome

The best evidence that Fed independence was not achieved at the March 1951 Treasury-Fed Accord is found in what transpired afterward.

A few days later, Thomas McCabe sent in what Robert L. Hetzel and Ralph F. Leach describe as “a bitter letter of resignation” in their 2001 Economic Quarterly article “The Treasury-Fed Accord: A New Narrative Account,” and Truman appointed Martin Fed chair. Whether Truman pushed McCabe out or McCabe resigned due to dissatisfaction with what was (or wasn’t) achieved by the accord, the thesis that the accord established Fed independence does not seem to hold up. Moreover, Eccles tucked his tail and retired from the board three months later.

According to Hertzel and Leach, “The initial reaction both among Board staff and on Wall Street to Martin’s appointment was that the Fed had won the battle but lost the war. That is, the Fed had broken free from the Treasury, but then the Treasury had recaptured it by installing its own man.” It’s difficult to reconcile the view that the Fed had become independent in 1951 with the fact that Truman appointed the assistant secretary of the Treasury—the same man who represented the Treasury’s interests in the famed meeting—the Fed chair a couple of weeks later.

Did Martin Flex the Fed’s Independence?

Proponents of the Fed independence myth point to William McChesney Martin Jr. as the Fed chair who helped the Fed flex its muscles and grow into its status as an independent agency. While Martin made public statements in favor of Fed independence, he also made public statements that contradicted that view. Consider, for example, what he said in a 1955 interview with U.S. News and World Report:

“Q: Do you have any obligation to help them finance the deficit?

“A: We do.

“Q: How do you derive that duty?

“A: Well, because we are a part of the government.”

The Fed chair saying that the Federal Reserve has an obligation to help the president and his Treasury finance the deficit is the exact opposite of independence. Martin also said: “We have a responsibility for seeing that money and credit is co-ordinated with the other Government activities” and “We can never omit the needs of the Treasury from our considerations.” He also dismissed the idea of separation between the Fed and the Treasury in favor of a fence with a “revolving door.”

More than a decade after the accord, in 1962, the chair of the Council of Economic Advisors (CEA) wrote to Martin saying, “Both [Treasury] Secretary Dillon and you referred to the fine cooperation that there had been all last year among the Treasury, the Federal Reserve, and the Council [of Economic Advisors]. I agree with that appraisal.”

“Fine cooperation” between the Fed, on the one hand, and the president’s administration, including the Treasury and the CEA, on the other, is also the opposite of Fed independence.

When John F. Kennedy reappointed Martin Fed chair in 1963, he said:

“Mr. Martin has cooperated effectively in the economic policies of this Administration, and I look forward to a constructive working relationship in the years ahead. As you know, the Federal Reserve System is a fully independent agency of the U.S. Government but it is essential that there exist a relationship of mutual confidence and cooperation between the Federal Reserve, the economic agencies of the Administration, including especially the Secretary of the Treasury, and the President.

“Mr. Martin has my full confidence, and I look forward to continuing to work with him and his colleagues on the Board in the interest of a stronger US economy.” (emphasis added)

You see on display here the sort of doublespeak about the Fed’s alleged independence that persists to this day. JFK acknowledged the Fed’s “independence” and in the same breath praised the “relationship” and “mutual confidence and cooperation” between the Fed and the administration.

Perhaps the most damning piece of evidence against the myth that Martin was a champion of Fed independence is that Martin endorsed JFK’s plan to make the Fed chair an effective member of the president’s cabinet. JFK proposed raising the salary of the Fed chair and the members of the board of governors to the salary of Cabinet members, making the Fed chair’s term coincide with that of the president, and having the Fed chair report to the president. The Business Weekly article on JFK’s proposal said there was no reason “to fear that in coordinating its activities with those of the rest of the government the Fed loses its independence. The Fed never has had the freedom to pursue a policy line without regard to what everyone else was doing, and it is unthinkable that it should.” It also said that the rest of the Board of Governors recognized the benefits of JFK’s proposal and that it would represent a culmination of the “record of cooperation” between the Fed and the rest of the government.

Cooperation in Word and Deed

Actions speak louder than words. Proponents of the independence myth point to the low inflation of the 1950s as evidence that the Fed had broken free from the Treasury. What they ignore, however, is that Eisenhower (elected in 1953) hated inflation. Indeed, in Robert Weintraub’s statistical analysis of monetary policy from 1951 to 1977, he concludes that “the dominant guiding force behind monetary policy is the President” and that “the historical records show that in each administration monetary policy fitted harmoniously with the President’s economic and financial objectives and plans.”

The harmony continues to this day. If you pull up any measure of government spending, deficits, and debt and compare it to the Federal Reserve’s monetary policy and balance sheet over time, you find a nice correlation. Whenever the government needs to borrow, the Fed stands ready to purchase more debt with new money.

This is especially visible in crises. During a crisis, the federal government explodes in size and scope. The Fed always accommodates with low interest rates, money printing, and debt purchases.

Moreover, Martin’s “revolving door” in the fence is still operational. The Treasury secretary and the Fed chair have regular meetings, and historically the best way to be appointed Fed chair is to either hold a high position in the Treasury Department or serve on the president’s council of economic advisors:

• Jerome Powell was assistant secretary and under secretary of the Treasury before he became Fed chair.

• Janet Yellen was chair of the CEA before and Treasury secretary after she was Fed chair.

• Both Ben Bernanke and Alan Greenspan were chairs of the CEA before their tenures as Fed chair.

• Paul Volcker was the director of the Treasury’s Office of Financial Analysis and deputy under secretary for monetary affairs at the Treasury before he was Fed chair.

Should the Fed Be Independent?

While it’s clear that the Fed did not achieve independence with the Treasury-Fed Accord of 1951, we haven’t discussed whether the Fed should be independent. Of course, the best outcome for the Fed is for it to be abolished. The worst-case scenario would be for the US government to abolish cash in favor of a central bank digital currency—this would remove the last remaining check (albeit a flimsy one) the public has on the cartelized banking system and the government’s ability to expropriate resources with monetary inflation.

Between these extremes, we can rank various institutional arrangements and monetary policies. The current arrangement involves independence in rhetoric alone. This allows the Fed and the presidential administration to play a silly finger-pointing game. President Trump can call Chair Powell a fool to blame bad economic outcomes on the Fed. Meanwhile, Powell, using characteristically passive Fedspeak, says that the federal debt is on an “unsustainable path.” They play out this drama, sometimes with rhetorical fireworks—Trump wanting to fire Powell and Powell insisting Trump has no legal authority to do so—but this a mere sideshow, a distraction. It’s kayfabe, to use professional wrestling lingo. Similarly, some Very Serious People imagine larger conflicts between the Fed and other central banks and come to the erroneous conclusion that the Fed is protecting American interests.

The true nature of the central bank is that it is the federal government’s money printer. It allows the government to expropriate resources to a greater extent than if the government had to rely on taxes alone. The dual mandate “balancing act” gives the impression that the Fed is trying to keep the macroeconomy on an even keel, but this is an illusion. The Fed’s true balancing act is to inflate as much as possible on behalf of the federal government without excessive negative political outcomes like financial crises, high unemployment, and unpopular price inflation. They pretend to avoid these inevitabilities of monetary manipulation out of a sense of public service, but it’s all PR and political games.

Explicit Fed dependence would be better. It would strip away the façade of impartiality, and ordinary people would be able to see who is responsible for high prices and business cycles. Is it the Fed or the federal government? Yes!

Fed independence platitudes are like the robes worn by Supreme Court justices. They provide the appearance of objectivity, sophistication, and sacredness. Underneath, it’s all politics.

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