What’s wrong with imposing political pressure on the Fed

A version of this post first appeared on AEI's blog, AEIdeas.

It’s not unreasonable to criticize Federal Reserve policymaking. Except maybe if you’re the American president.

There’s good reason it’s considered exceedingly bad form and poor governance to do what President Trump is doing right now in his escalating critique of the Fed under Chairman Jerome Powell. If you value economic stability, then you probably don’t want the president using political pressure to influence the U.S. central bank.

As history shows, it can get really ugly.

Andrew Harrer/Bloomberg

In the 1960s, President Johnson went to war with the fiscally conservative Fed boss William McChesney Martin, who worried about the inflationary risk from LBJ’s guns-and-butter economic policies. Johnson saw Martin’s tighter monetary policy as undermining his agenda, even asking the U.S. attorney general if a president could remover a Fed board member from office. After the Martin Fed raised the discount rate in late 1965, LBJ summoned Martin to his Texas ranch to explain himself, leading to the famous confrontation where the president pushed the shorter Martin against a wall and told him that “my boys are dying in Vietnam, and you won’t print the money I need.” Martin stood his ground policywise and is praised for helping maintain Fed independence (although he probably should have tightened more aggressively).

Then there was President Nixon vs. Chairman Arthur Burns, where the president pressured Burns to run an expansionary monetary policy in the run-up to the 1972 election. As is recounted in the 2006 paper “How Richard Nixon Pressured Arthur Burns: Evidence from the Nixon Tapes” by Burton Abram, a professor of economics at the University of Delaware, this was done both through face-to-face conversation — as White House audio recordings reveal — and through other tactics such as leaks that Nixon was considering expanding the size of Fed membership or otherwise giving the White House more control over monetary policy. Abram concludes:

Without invoking political pressure, the surge of expansionary monetary policy leading up to the 1972 election seems hard to explain. After all, Arthur Burns knew better than to run a heavily expansive monetary policy after the recession had ended in November 1970 and in an already-inflationary environment. … It is hard to understand how a man of Arthur Burns’s experience, intellect, and political know-how could be pressured into abandoning his better judgment. … Whether Burns responded to political pressure or out of personal economic convictions to return the economy quickly to full employment may never be definitively determined. Yet, one wonders, had there been no political connection between Burns and Nixon, would Burns have been so eager to run an expansionary monetary policy in late 1971 and into 1972? Without the political connection, might Burns instead have sided with his Vice Chairman Alfred Hayes in arguing against greater monetary ease? Regardless of the ultimate source of Arthur Burns’s motivation, his actions as Federal Reserve chair helped to trigger an extremely costly inflationary boom-bust cycle.

After the economically volatile 1970s, presidents learned their lesson. President Reagan famously supported the extraordinary tightening cycle launched by Paul Volcker, despite enormous criticism amid rising unemployment. (As the Minneapolis Fed noted in a 2009 interview with Volcker, “Building contractors shipped two-by-fours to his office and farmers protested on tractors in front of the Fed; one powerful congressman demanded his impeachment.”) But Reagan didn’t abandon Volcker.

As George Shultz, secretary of state under Reagan, once put it:

Well, to do something difficult, even if you are the independent Federal Reserve, it makes a huge difference if the president is on your side and is strong and understands the problem, and when things get tough he doesn’t go the other way and denounce you, but holds in there. That was one thing about President Reagan: He understood these major developments, and he wanted to be president because there were things he wanted to do as president. And so when he took actions that he thought were right, knowing that there could be difficulties, he stuck with them, he didn’t run away. He had a stiff backbone.

It’s a bad sign that Trump has gone wobbly over a modest monetary tightening during a lengthy expansion, while Reagan stood fast during a deep recession and historic rise in rates. Perhaps the blowback against his comments will show the president that it really is in his interest to keep quiet and let Congress, the media and Wall Street scrutinize Fed policy. If the central bank thinks White House comments are seriously casting doubt on its independence, it might be forced to tighten even more to send a reassuring message to inflation-wary markets. And that’s the last thing Trump wants.