Central Banking
in a Democracy
Alan S. Blinder
On September 26, 1996, Alan S. Blinder presented the following speech
at the Federal Reserve Bank of Richmond. The text of the speech is
printed below after J. Alfred Broaddus’s introduction of the speaker.
It is a pleasure to welcome all of you this afternoon for this latest program
in our series of occasional lectures by distinguished economists on major
economic policy issues. Largely for convenience, we hold these programs here
at the Richmond Fed, and we are delighted to host them. But let me remind
you that they are jointly planned and funded with the three university business
schools here in Richmond. I’d like to introduce my colleagues in this
endeavor: Dr. Al Altimus, Dean of the Lewis School of Business at Virginia
Union University; Dr. Randolph New, Dean of the Robins School of Business
at the University of Richmond; and Dr. Howard Tuckman, Dean of the School
of Business at Virginia Commonwealth University. It’s been a great pleasure
working with these folks over the years and I think it’s been a very productive
collaboration. I would also like to recognize my colleague, Marvin Goodfriend,
who is Senior Vice President and Director of Research here at the bank. Marvin
is my principal adviser and has played a leading role in planning and putting
on these programs in recent years.
It’s a particular personal pleasure and an honor to introduce our speaker.
Alan Blinder, to put it bluntly but accurately, is one of the most distinguished
macroeconomists in the world today. He has done about everything any economist
and even a leading economist would do. He earned a Ph.D. from a
leading economics department, MIT. He has taught and is teaching at a top
university, Princeton, which also happens to be his undergraduate alma mater.
He has published numerous scholarly articles in professional journals, a leading
The views expressed are those of the speaker and do not necessarily represent those of the
Federal Reserve Bank of Richmond or the Federal Reserve System.
Federal Reserve Bank of Richmond Economic Quarterly Volume 82/4 Fall 1996 1
2 Federal Reserve Bank of Richmond Economic Quarterly
economics textbook, and a number of other books, including a little gem on
major economic policy issues called Hard Heads, Soft Hearts. Finally, he has
served as an economic policymaker at the highest level. Early in his career, in
the mid-’70s, he was brieﬂy Deputy Assistant Director of the Congressional
Budget Ofﬁce when it was just getting started. More recently, of course, he
was a member of the President’s Council of Economic Advisers in the ﬁrst
year and a half of the Clinton Administration. In that capacity, he was a leading
economic policy adviser to the Administration. Subsequently he was our
colleague at the Fed, serving as Vice Chairman of the Board of Governors of
the Federal Reserve System from June 1994 until he departed early this year to
return to Princeton, where he is the Gordon S. Rentschler Memorial Professor
of Economics. Some of you who have been attending these lectures regularly
will remember that we had Alice Rivlin here not too long ago. She has now
become the Vice Chairman of the Board of Governors. We wanted to give an
equal opportunity to former Vice Chairmen of the Federal Reserve Board.
It’s not an idle compliment when I say that as a veteran Fed employee, I
greatly enjoyed Alan’s all-too-brief tenure at the Fed. Let me share with you a
little Fed secret. It’s not about interest rates, but about the Federal Open Market
Committee, which as you know is the main policymaking body in the Fed. It’s
a strong and I believe effective committee, but it is not always a terribly lively
committee. It was, however, a much livelier committee when Alan was part of
it. He challenged us—and also helped us—to confront issues objectively with
careful and solid economic analysis. He helped take the edge off the debates
that we had in the committee during his tenure with keen and well-timed humor.
And he raised the level of discussion in the committee during his tenure. I miss
his input very much. It’s good to have him back in Richmond. He was here
about a year-and-a-half ago and gave a great lecture to the Virginia Bond Club.
Please join me in welcoming back Dr. Alan Blinder.
A
l, thank you very much for that ﬁne introduction. I want to talk this
afternoon about the role of the Federal Reserve in society in very
broad terms and, along the way, to make a few rather more speciﬁc
points. Then I will be glad to entertain questions about what interest rates will
do next week, a subject about which I know nothing! But neither does anyone
else, so we are all on an equal footing on the subject.
WHO DOES THE FED SERVE?
Relative to their economic and therefore social importance, central banks must
be among the least well understood institutions in the entire world. For example,
I have been told that millions of Americans still think that the Federal Reserve
A. S. Blinder: Central Banking in a Democracy 3
System is a system of government-owned forests and wildlife preserves where,
presumably, bulls and bears and hawks and doves frolic together in blissful
harmony. Having spent 19 months there, I can assure you that that is not the
case. The Federal Reserve is an institution that touches almost everyone in
America, plus many people outside America, but is itself touched or even seen
by relatively few. But its traces are everywhere. Every time you pay or receive
paper currency, you are using a “Federal Reserve Note”—a debt obligation of
the Fed. Unbeknownst to most of you, your checks are also probably cleared
through a regional Federal Reserve Bank; and, if you bank here in Richmond,
through this regional Federal Reserve Bank.
When you read in a newspaper ad that a certain bank will pay you 5.7
percent on a certiﬁcate of deposit or you hear on television that an automobile
company this week is offering 4.9 percent ﬁnancing, you are seeing tangible
evidence of the Fed’s regulatory hand at work. Very few people have any idea
that it is the Fed that tells banks and auto ﬁnance companies how to calculate
and advertise those numbers. And even fewer know that the Fed doesn’t always
get it right!
The interest rates themselves, while set in free markets, are heavily inﬂuenced
by the Fed’s monetary policy. Most Americans these days know that,
but few can tell you how that black magic is performed. Even fewer people
understand how the Fed’s interest rate decisions impact on the overall economy
and therefore inﬂuence how many people will ﬁnd jobs, how many will be laid
off, how many businesses will succeed, how many will fail. Most economists
will attest to the fact that the Fed has far more inﬂuence over these matters
than the President and Congress.
The Federal Reserve System has a governance structure that is at least odd
and perhaps even byzantine. While most countries in the world have one central
bank, we have 12—the one here in Richmond and 11 others. These regional
Federal Reserve Banks are, in a legal sense, private corporations. They have
presidents, in this case Al Broaddus, and boards of directors. They even have
shareholders. And while these corporations are extremely proﬁtable—to the
tune of over $20 billion a year for the 12 of them together—their shareholders
do not reap the beneﬁts. Instead, the Fed’s prodigious proﬁts are turned over
to the United States Treasury—a very friendly gesture. Atop this organization
of 12 putatively private corporations, there sits a seven-member Board of
Governors in Washington, whose members are not elected by any of the stockholders,
but rather are politically appointed. A very, very curious organizational
structure.
So the question arises: Who does the Fed serve? Congress and the President?
Most certainly not. Although the Fed is a creature of Congress, and its
governors are all presidential appointees, the Fed does not exist to do their
bidding. After all, that would make a mockery of the doctrine of central bank
independence.
4 Federal Reserve Bank of Richmond Economic Quarterly
What about the banks? Well to some extent, the answer must be yes. The
Fed is a bank for banks. It sells to these banks a variety of services, many
of them in direct competition with private suppliers. The Fed is also deeply
concerned with the health of the banking and payments system and will, when
necessary, take strong steps to safeguard it. However, the Federal Reserve is also
the supervisor of thousands of banks, either directly or indirectly, through their
bank holding companies. (The Fed supervises all the bank holding companies.)
It is a very odd arrangement when you think about it: The Fed is regulating
its own customers. There are a lot of businesses in America that would like
to regulate their own customers, but very few get to do that. In my view, it is
a great mistake for the Federal Reserve to see itself as a service organization
for the beneﬁt of banks, however. It is a mistake that people in the Federal
Reserve System make occasionally, but fortunately not very often.
Does the Fed serve the ﬁnancial markets? As the nation’s central bank, the
Fed is naturally and certainly the ultimate guardian and protector of the entire
ﬁnancial system. In times of acute market distress, the Fed stands ready to play
its classic role as lender of last resort. In more normal times, the Fed worries
about such things as the integrity of the markets, ﬁnancial fragility, speculative
bubbles, the value of a dollar, and a host of other things. As I used to say when
I was Vice Chairman of the Fed, we get paid, though not very much, to worry
about everything.
But, in my view, none of these choices—not the President, not the Congress,
not banks, not the ﬁnancial markets—adequately describes the Fed’s
true constituency. In my view, that constituency can only be the entire nation.
While I was on the Federal Reserve Board, I often said that I viewed myself as
working for 260 million Americans. Given the central bank’s broad reach and
pervasive inﬂuence, no narrower constituency seemed appropriate. So I want
to talk this afternoon about what the Federal Reserve does and should do to
serve the national interest.
I think it would surprise most of you to learn that a time-and-motion study
of the daily lives of Federal Reserve Governors would reveal that most of their
efforts are devoted to bank regulatory issues, broadly deﬁned. Most of this
business is routine, extremely familiar, and intensely interesting to the banking
industry, and totally unknown, deeply obscure, and generally quite boring to
everybody else in society. This is the Federal Reserve that nobody knows. So
as not to bore you with these matters, I will skip directly to the Federal Reserve
that everybody knows, for nowhere is the Federal Reserve’s public service role
more visible than in the conduct of monetary policy. It is monetary policy that
puts the Fed in the news constantly, and occasionally puts it in the middle of
a political maelstrom.
If you don’t live your life in the ﬁnancial world, it is almost impossible
to imagine how tightly focused the media and the markets are on the Federal
Reserve. Fixated is not too strong a word. “Federal Reserve fetish” has not
A. S. Blinder: Central Banking in a Democracy 5
yet come into current use as a term of art, but I think it describes a lot of
the behavior of the ﬁnancial press and people in the ﬁnancial markets. To the
ﬁnancial press, a Federal Reserve Governor is more engaging than a movie
star. (Think about that one for a while!) When I was Vice Chairman of the
Federal Reserve Board, I simply came to expect to ﬁnd 15, 20, or 25 reporters,
plus several TV cameras, waiting any time I made a public appearance—no
matter how boring my speech was going to be. (This, as you’ve noticed, doesn’t
happen to me anymore.)
Things were not always this way. The story is told that the only way
President Kennedy could remember the difference between monetary policy
and ﬁscal policy was that the letter “M” for monetary was also the ﬁrst letter
of the name of the Fed Chairman at that time, William McChesney Martin.
Times have sure changed. I can assure you that President Clinton had no such
problem, and neither did President Bush.
THE GOALS OF MONETARY POLICY
Just how is the Fed supposed to serve the national interest with this strange instrument
called monetary policy? Under the terms of the Federal Reserve Act,
as amended, Congress has directed the Fed to promote “maximum employment,
stable prices, and moderate long-term interest rates.” That sounds like
three goals, but the phrase is often called the Fed’s “dual mandate” because
the interest rate objective is considered redundant. Price stability will almost
certainly bring low long-term interest rates in its wake.
At this point, I need your indulgence for a very brief Economics 101 lecture
on how monetary policy affects employment and inﬂation. It all works roughly
as follows.
In the short run, employment is largely determined by total spending in the
economy. Interest rates are one, though not the only, important determinant of
that spending. So the Federal Reserve, via its effect on market rates of interest,
exerts considerable indirect inﬂuence over employment and unemployment.
But the process takes time. As economists put it, monetary policy works with
long lags. While the lagged effects of monetary policy on unemployment are
distributed through time—a little now, a little more the next quarter, and so
on—it won’t hurt you to think of them as taking about a year or two.
Changes in inﬂation, up or down, are largely determined by the balance
between total spending, which is heavily inﬂuenced by monetary policy, and
the economy’s capacity to produce, which is not. If spending falls short of the
economy’s productive capacity, as happens in a recession, inﬂation will fall. If
spending overshoots capacity, as sometimes happens in a boom, inﬂation will
rise. But the lag from monetary policy decisions to inﬂation is even longer than
the lag from monetary policy to employment because monetary policy ﬁrst has
to affect spending, and then spending must affect inﬂation. Think of the whole
6 Federal Reserve Bank of Richmond Economic Quarterly
process—from a decision of the Federal Reserve on monetary policy to the
reaction of inﬂation—as taking more than two years.
The central dilemma of monetary policy is this: Unless inﬂation is below
the Federal Reserve’s long-run target, which hasn’t been true in a very long
time, there is a short-run trade-off between the two goals—maximum employment
and stable prices—that are set forth in the Federal Reserve Act. To push
inﬂation lower, the Fed must make interest rates high enough to hold total
spending below the economy’s capacity to produce. But if it does that, the
Federal Reserve will be reducing employment, contrary to the dictum to pursue
“maximum employment.” So monetary policy is forced to strike a delicate
balance between the two goals. It is an excruciatingly difﬁcult decision, with
a great deal at stake. As a former holder of my former ofﬁce once quipped,
“That’s why they pay them the big bucks!”
THE TRADE-OFF AND JACKSON HOLE
Early in my term as Vice Chairman of the Fed, I allegedly stirred up a
controversy at a Federal Reserve conference in Jackson Hole, Wyoming, by
acknowledging this trade-off explicitly. The context is important to an understanding
of what happened, because the subject of that conference was reducing
unemployment. Being a central banker at the time, I thought it was appropriate
for me to address the role of central banks in that task. In my brief remarks,
I noted that monetary policy actions have a profound effect on employment. I
also suggested that a central bank could do its part to achieve low unemployment
by pushing the nation’s total spending up to the level of capacity, but not
further. I observed that the Fed’s dual mandate could reasonably be interpreted
in precisely that way. So I endorsed that mandate as eminently reasonable
instructions for the Congress to have given the Fed, rejecting the alternative of
concentrating exclusively on price stability and ignoring unemployment.
Nothing I said at Jackson Hole that day was really controversial, and certainly
nothing was original. My conceptualizations of monetary policy’s role
and of the trade-off between inﬂation and unemployment were totally conventional.
My endorsement of the Fed’s dual mandate meant that the Vice
Chairman of the Federal Reserve was publicly endorsing the Federal Reserve
Act. Now there’s news for you! Furthermore, my implied “advice” to central
bankers was fully consistent with the practices of central banks all over the
world, regardless of what they preach. Indeed, I think a very fair academic
critique of my little talk that day would have labeled it banal. Had a student in
a course submitted that talk to me as a paper I think I would have said, “There
is not an original idea here. You have to be able to do better than this.”
About a dozen ﬁnancial journalists were in the audience that day, and all
but one of them heard it that way. But Keith Bradsher of The New York Times
A. S. Blinder: Central Banking in a Democracy 7
decided that he had just heard “a big story.” I had, he was led to believe by some
anonymous whispers, violated the sacred trust of central bankers by saying a
few obvious things out loud. He told readers of The Times that I had publicly
clashed with the Fed Chairman. That’s funny; Alan Greenspan was sitting right
there as I spoke, and he didn’t hear it that way at all. I know, because the two
of us had breakfast together the next morning, and he never indicated that I
had said anything unusual—which I hadn’t. No matter. On a slow news day
in August Bradsher’s story from Jackson Hole wound up on page one of The
New York Times.
Media ﬁrestorms have a life of their own and, until you have been the
subject of one, it is hard to imagine what they are like. For more than a month,
a seemingly unending barrage of stories appeared in newspapers, magazines,
over the ﬁnancial wires, and even on TV and radio. I was made “controversial,”
which is one of the ways they try to stick the knife in you in Washington. The
Fed, the public was told, had an outspoken new Vice Chairman who had broken
several central banking taboos and publicly tangled with his Chairman. The
hysteria reached a crescendo with truly a malicious attack published in both
Newsweek and The Washington Post by Robert Samuelson, who decided—
without ever bothering to call me up even once to talk about my views—that
I was unﬁt both morally and intellectually to lead the Fed. One would be
okay, but both morally and intellectually? Whoever said that serving in the
government isn’t fun?
I recount this episode not to dredge up the ghosts of irresponsible journalists’
pasts, but for three reasons that are closely related to today’s topic.
The ﬁrst is to give you a little window into what can happen when a Federal
Reserve Governor publicly endorses the view that the Federal Reserve should
be serving the national interest rather than just the parochial interests of the
bond market. But I must insist that serving the national interest is the only
correct way to conceptualize the Fed’s mission; to me, the issue is not open to
either compromise or debate.
The second reason is to tell you that I remain totally unrepentant and never
retreated one inch from the position that I enunciated that day—not in public,
and not inside the Federal Reserve. What I said that day was true then, and
it is true now. There is abundant evidence that Keynes was right back in the
’30s when he said that modern industrial economies are not sufﬁciently selfregulating.
They need a little help. Total spending sometimes roars ahead of
productive capacity, which leads to accelerating inﬂation. And total spending
sometimes lags behind productive capacity, leading to unemployment.
In principle, either ﬁscal policy—the government’s taxing and spending
policy—or monetary policy could serve as the balance wheel, propping up
demand when it would otherwise sag and restraining it when it threatens to
race ahead too rapidly. In practice, however, monetary policy is the only game
in town nowadays. And when I say “in town,” I don’t mean just in Richmond
8 Federal Reserve Bank of Richmond Economic Quarterly
or just in the United States—I mean all over the industrial world. The reason
is the same here and in Europe: The need to reduce large ﬁscal deﬁcits dictates
that budget policy remain a drag on total spending for the foreseeable future,
regardless of the state of the macroeconomy. With the ﬁscal arm of stabilization
policy thereby paralyzed, a central bank that decides to concentrate exclusively
on price stability is, in effect, throwing in the towel on unemployment.
So, to me, the argument for the Fed’s dual mandate is both straightforward
and convincing. The central bank exists to serve society. The public cares
deeply about ﬂuctuations in the pace of economic activity. And well-executed
monetary policy has the power to mitigate ﬂuctuations in employment. As the
mathematicians say, “QED.” Fortunately, almost all central bankers accept this
argument nowadays, notwithstanding a great deal of misleading rhetoric to the
contrary.
That leads me straight to the third reason for telling you the Jackson Hole
story. As a citizen of a democracy, I have always found it intolerable for
the government to deceive the governed. As a public servant, I also found it
unconscionable. And I see no reason whatsoever why the central bank should
have a special exemption from the requirement to level with the public.
CREDIBILITY
It is sometimes argued, to the contrary, that honest acknowledgment of the
trade-off between unemployment and inﬂation, and of the central bank’s concern
with each, would rattle the ﬁnancial markets—which want to believe that
the central bank cares only about low inﬂation. This argument is nonsense.
Both market participants and the ﬁnancial press know the score and are far
too sophisticated to be taken in by ritualistic rhetoric. I remember very well a
conversation I had with a very smart ﬁnancial reporter shortly after I left the
Fed. He said that he has learned over the years to ignore what the Fed says
and watch what it does. I had to concede that he was right, but it troubled me
a great deal that the two would be so different. In my view, they should be a
matched pair.
There is much talk at the Federal Reserve, as in the central banks all over
the world, about the importance of credibility, which, according to the dictionary
in my ofﬁce, is “the ability to have one’s statements accepted as factual or
one’s professed motives accepted as the true ones.” Let me read the last phrase
again: “one’s professed motives accepted as the true ones.” Precisely the point!
Why is credibility considered so important?
The main reason, in my view, is that a central bank is a repository of
enormous power over the economy. And if the central bank is independent,
as the Federal Reserve is, this power is virtually unchecked. Such power is
a public trust, assigned to the bank by the body politic through its elected
representatives. In return, the citizens and their elected representatives have a
A. S. Blinder: Central Banking in a Democracy 9
right to expect—indeed to demand—that the bank’s actions match its words.
And matching deeds to words is, to me and to my dictionary, the hallmark of
credibility.
CENTRAL BANK INDEPENDENCE
The Fed’s role as the macroeconomic balance wheel is terribly important because
it palpably effects people’s lives. Stabilization policy is not something
abstract; it is about how many jobs there will be, how many businesses will
succeed. In my view, it is far and away the most important thing a central bank
does for or to its society. And I felt that responsibility keenly every day that I
served as Vice Chairman of the Fed, as I know Al Broaddus still does in his
role as a member of the Federal Open Market Committee. Society, therefore,
has a strong interest in seeing to it that the central bank does its job well.
Evidence collected in recent years suggests that making the central bank more
independent should help.
Before elaborating on this point, however, I need to deﬁne what I mean by
an independent central bank—because there is no agreed-upon deﬁnition. To
me, the term connotes two things.
The ﬁrst is that the central bank is free to decide how to pursue its goals.
This freedom does not mean that the Bank gets to select the goals on its own.
On the contrary, in a democracy it seems not just appropriate, but virtually
obligatory, that the political authorities should set the goals and then instruct—
and I use that verb advisedly—the central bank to pursue them. If it is to be
independent, the bank must have a great deal of discretion over how to use its
instruments in pursuit of its assigned objectives. But it does not have to have the
authority to set the goals by itself. Indeed, I would argue that giving the bank
such authority would be an excessive grant of power to a bunch of unelected
technocrats. In a democracy, the elected representatives of the people should
make decisions like that. The central bank should then serve the public will.
The second critical aspect of independence, in my view, is that the central
bank’s decisions cannot be countermanded by any other branch of government,
except under extreme circumstances. In our system of government, neither the
President nor the Supreme Court can reverse a decision of the Federal Open
Market Committee. Congress can, in principle, reverse such a decision, but only
if it passes a law that the President will sign (or by overriding a presidential
veto). This makes the Fed’s decisions, for all practical purposes, immune from
reversal; and, indeed, they never have been reversed. Without that immunity,
the Fed would not really be independent, for its decisions would stand only as
long as they did not displease someone more powerful.
In recent years, considerable empirical evidence has accumulated in support
of the idea that macroeconomic performance is superior in countries that have
more independent central banks. Researchers here and in other countries have
10 Federal Reserve Bank of Richmond Economic Quarterly
developed several creative ways to measure central bank independence. Such
measures include the bank’s legal status, the rate of turnover of its leaders,
the legal mandate in the bank’s charter (for example, whether it is directed to
pursue price stability), and answers to a questionnaire about its organizational
structure. The clear weight of this evidence, and by now there is a lot of
it, is that countries with more independent central banks have enjoyed lower
average inﬂation without suffering lower average growth. This ﬁnding is, of
course, completely consistent with economists’ general view that, while there is
a short-run trade-off between inﬂation and unemployment, there is no long-run
trade-off.
These research results on the beneﬁts of central bank independence raise a
provocative question: Why is it that central banks possessing greater independence
produce superior macroeconomic results on average? I want to suggest
three reasons, all closely related.
First, as I emphasized in my brief Economics 101 lecture a couple of minutes
ago, the effects of monetary policy come with long lags. So, to conduct
monetary policy well, you must look far in the future and then wait patiently
for the results. Farsightedness and patience, I dare say, are not the strong suits
of the political process in a democracy. But they are absolutely essential to
pursuing a successful monetary policy.
Second, and related to the time-horizon question, inﬂation-ﬁghting has
the characteristic cost-beneﬁt proﬁle of a long-term investment: You pay the
costs of disinﬂation up front, and you reap the beneﬁts—lower inﬂation—only
gradually through time. So, if politicians were to make monetary policy on a
day-to-day basis, they would be sorely tempted to reach for short-term gains at
the expense of the future—that is, to inﬂate too much. Aware of this temptation,
many governments wisely depoliticize monetary policy by delegating authority
to unelected technocrats with long terms of ofﬁce, thick insulation from the
hurly-burly of politics, and explicit instructions to ﬁght inﬂation.
Third, and related to this point about technocracy, the conduct of monetary
policy is at least somewhat technical. It is a bit like shooting a rocket
to the moon, though not nearly as exact. Very few elected ofﬁcials in this or
other countries have much understanding of how the monetary transmission
mechanism works, of the long lags that I have mentioned, or of a variety of
other technical details about monetary policy. So countries can probably get
higher-quality monetary policy by turning the task over to trained technicians,
subject, of course—and this is important in my view—to political oversight.
CENTRAL BANK INDEPENDENCE AND DEMOCRACY
At this point, a very deep philosophical question arises: Isn’t all this profoundly
undemocratic? Doesn’t assigning so much power to unelected technocrats
A. S. Blinder: Central Banking in a Democracy 11
contradict some fundamental tenets of democratic theory? It is a legitimate
question. My answer is: If you assign this power well, it needn’t be antidemocratic.
And I want to conclude this lecture with a detailed defense of that
answer. The question is: How can an independent central bank be rationalized
within the context of democratic government? My recipe comes in six parts.
First, we all know that, even in democracies, certain decisions are reserved
to what is sometimes called the “constitutional stage” of government, rather
than left to the daily legislative struggle. These are basic decisions that we do
not want to revisit often; they should, therefore, be hard to reverse. So, for
example, amending the U.S. Constitution requires much more than majority
votes of both houses of Congress. The Founding Fathers thereby made it almost,
but not quite, impossible to change certain basic provisions of law. And
they meant it that way; it wasn’t an accident.
Similarly with monetary policy. The Fed’s independence, which derives
from authority delegated by Congress, makes it very difﬁcult, but not quite
impossible, for elected ofﬁcials to overrule or inﬂuence a monetary policy
decision. Wise politicians made a once-and-for-all decision years ago to limit
their own power in this way just as, for example, the Constitution made it very
difﬁcult to change the length of the President’s term of ofﬁce. The reasoning
was precisely the same as that which led Ulysses to tie himself to the mast.
He knew he would get better long-run results even though he wouldn’t feel so
good about it in the short run!
The second ingredient that helps make central bank independence consistent
with democratic theory is something I emphasized earlier: The bank’s basic
goals are chosen by elected politicians, not by unelected technocrats. So, for
example, when people suggest to me that the Fed should content itself with
3 percent inﬂation, I always answer, “the Federal Reserve Act, which is the
law of the land, says ‘stable prices,’ not ‘pretty low inﬂation.’ ” If the citizens
think that is wrong, they should get the law changed. Until they do, the Federal
Reserve should obey the law.
Third, the public has a right to demand honesty from its central bankers.
This, again, is a point I made earlier in discussing the idea of credibility, which
I deﬁned as matching deeds to words. The central bank, in my view, owes this
to the body politic in return for the broad grant of power it enjoys.
The fourth ingredient is closely related to this last point. I call it accountability,
or perhaps just openness. Monetary policy actions have profound effects
on the lives of ordinary people. In my view, a central bank in a democracy
therefore owes these folks an explanation of what it is doing, why it is doing
it, and what it expects to accomplish by its actions. As I often said while I
was at the Fed, “It’s their economy, not ours.” By offering a reasonably full
and coherent explanation of its actions, the central bank can remove much
of the mystery that now surrounds monetary policy, enable interested parties
to appraise its decisions contemporaneously, and then—importantly—allow
12 Federal Reserve Bank of Richmond Economic Quarterly
outsiders to judge its success or failure after the fact, for the verdict of history
is the only one that ultimately matters.
Let me assure you that greater openness is not a popular cause in central
banking circles, where some see mystery as essential to effective monetary policymaking.
Making the central bank more open and accountable, it is alleged,
may subject it to unwelcome scrutiny that could threaten its independence.
I couldn’t disagree with this argument more. In fact, I think it gets matters
exactly backward. To me, public accountability is a moral corollary of central
bank independence. In a democratic society, the central bank’s freedom to
act implies an obligation to explain itself to the public. Thus independence
and accountability are symbiotic, not conﬂicting. Accountability legitimizes
independence within a democratic political structure.
Nor, by the way, do I accept the claim, heard so much in central banking
circles, that more accountability will harm the central bank—as long as
the bank is independent. If the central bank makes good decisions, it should
have no trouble explaining them to the public. If the Fed cannot articulate
a coherent defense of its actions, maybe those decisions are not as good as
it thinks. Indeed, being forced to articulate such a defense would probably
be a good disciplinary device. Remember—and this is critical—I am talking
here only about explaining the decisions after they are made, not putting them
to a vote!
The Federal Reserve, tight-lipped as it is, is far from the worst offender
in this regard. In fact, the Fed is probably more open and accountable than
most central banks in the world. But the competition in this league is not very
stiff—I think the New York Jets could win the championship in this particular
league—and I believe the Federal Reserve could and should go much further.
After all, we live in the most open society on the face of the earth, so just to say
that we’ve beaten the world average is no great achievement for Americans.
The ﬁfth ingredient in my democratic stew is that the leaders of the central
bank should be politically appointed by the President, as is the current practice.
When I went to the Federal Reserve Board in June 1994 as the ﬁrst appointee
of President Clinton, I joined Alan Greenspan, Mike Kelley, and John LaWare,
who were originally sent there by President Reagan, and Larry Lindsey and
Susan Phillips, who were appointed by President Bush. None of us was ever
elected to anything. But Bill Clinton and George Bush and Ronald Reagan
were. We obtained our political legitimacy from the men who appointed us,
and they in turn got it the old-fashioned way—directly from the voters. That
is as it should be.
Finally, the sixth ingredient—which I would argue should be present, but
very rarely used: Central bank decisions should be reversible by the political
authorities, but only under extreme circumstances. Reversal should not be routine
occurrences. As I’ve mentioned already, a Federal Reserve decision on
monetary policy can, in principle, be overturned by an act of Congress. And
A. S. Blinder: Central Banking in a Democracy 13
Fed governors can be removed from ofﬁce for good cause. These mechanisms
have never been used in the history of the Federal Reserve; but America is wise
to have them in place nonetheless. Delegated authority should be retrievable,
not absolute.
A SUMMING UP
So, in summary, let us review how the Fed, or any other central bank for that
matter, can best serve its nation with monetary policy.
To begin with, the central bank must always remember that it exists as
a public institution chartered to serve the broad national interest, not the
parochial interests of either the banking industry or the bond market. Often
those interests coincide. But when they clash, the central bank should not
hesitate before taking sides.
The highest calling of the central bank is to help stabilize the national
economy. For if the bank should fail at this task, no one else will be around to
pick up the pieces. In its role as macroeconomic steward, the Fed, I believe,
should pursue two goals—both low unemployment and low inﬂation—not
just one. That is what the people want and, in my view, the people have
got it right.
A central bank can perform its monetary policy role better if it’s independent
from political manipulation, and that’s probably why more and more
governments around the world are granting their central banks independence
these days.
Even though the Fed’s independence looks superﬁcially undemocratic, I
believe it is consistent with democratic theory for several reasons: it is based
on authority delegated by Congress; the basic goals of monetary policy are
set legislatively; the leaders of the Fed are appointed by the President; and
Congress retains ultimate control in case of dire emergency. But a central bank
in a democracy has a duty to level with the public it serves, not to obfuscate. I
used to ask some of my colleagues on the Federal Reserve staff in Washington
what they would have thought if their father, every time he spanked them,
had only said that he was doing it “to promote sustainable non-inﬂationary
growth”—and nothing more. I don’t believe that would have been considered
good parenting, and I don’t think it’s good central banking. More fulsome
explanation is appropriate.
A great Virginian, probably the greatest Virginian, once wrote, “Governments
are instituted among men” (I’m sorry it was only men in those days)
“deriving their just powers from the consent of the governed.” It is very hard
for the governed to give their consent if they don’t have a clue about what is
going on. Openness, accountability, and credibility are therefore, in my view,
moral corollaries of central bank independence.
14 Federal Reserve Bank of Richmond Economic Quarterly
Furthermore, and ﬁnally, I dispute the notion that is so popular in some
circles that monetary policy is best done amidst mystery, blue smoke, and
mumbo jumbo. Central banks work their will through ﬁnancial markets, and
economists rarely argue that markets function better when they are less well
informed. In my view, some small portion of the prodigious uncertainties over
the effects of monetary policy exists because the markets have a hard time
divining the Fed’s intentions. This particular source of uncertainty can, and in
my opinion should, be removed by greater openness. But that, I’m afraid, is a
story for another lecture and another day.