Did central banks gain too much clout in pandemic: An economist explains

Christina Parajon Skinner, an assistant professor at the Wharton School and former legal counsel at the Bank of England, probe the question.

Central banks were the first economic responders to the Covid-19 pandemic. From Washington to Wellington, policy makers swiftly deployed tools developed during the global financial crisis and found new ways to shore up credit markets vital to the functioning of modern commerce. 
 

Learning from the 2007-2009 fiasco, they moved with great speed and scope. Monetary authorities were aided by their independence: They had credibility with investors and businesses that allowed them to take bold steps and weren’t subject to the political horse trading and delays that usually come with fiscal stimulus. But some lessons may have been taken too far. Do central banks have too much clout and shape policy too expansively in too many areas? If so, does that imperil the very autonomy that makes them so effective? Christina Parajon Skinner, an assistant professor at the University of Pennsylvania’s Wharton School and former legal counsel at the Bank of England, probes these questions extensively in her “Central Bank Activism” paper, scheduled to be published next month in the Duke Law Journal. 

I discussed with Skinner how the Fed used the enormous power at its disposal — and the potential costs of such a muscular role — particularly in light of the current White House deliberations over whether to nominate Federal Reserve Chair Jerome Powell for a second term. (Fans say Powell did a good job during a once-in-a-lifetime crisis, while most detractors claim he was too easy on banks and is insufficiently attentive to environmental concerns. There are also upcoming vacancies for the positions of Fed vice chair and vice chair for supervision.) The transcript has been edited for length and clarity.

DM: A barrage of emergency measures have been called upon twice within 12 years. Can they even be called unconventional anymore and how likely is it that central banks go down this route time and again?

CPS: The door is open. There is a playbook now that has proven capable of accomplishing the goals for which it was intended: stabilizing the financial system and avoiding a repeat of the Great Depression. I wouldn’t be surprised at all if, during the next crisis, these plays are used again; similar programs get rolled out. There is an ongoing discussion about whether a certain number of these crisis facilities should be made standing facilities so that we do have some firmer criteria and trappings of accountability ingrained within law or regulation.

An important point to note here is the Main Street Lending Program, which was an important yet unprecedented thing the Fed did in 2020. To be clear, this was not the Fed acting on its own. Congress expressly asked and authorized the Fed to do this, but for the Fed to lend to this sector of the economy did seem to roll back some of the revisions to the Federal Reserve Act that previous Congresses had made.

The Federal Reserve Act used to permit this kind of an industrial lending role for the Fed. That was taken out of the Act in 1957. It’s not at all clear whether the Cares Act is a one-time authorization to lend to the real economy or whether the Fed now has authority to reincarnate a version of this in the future for the purposes of helping small business or municipalities that suffer losses due to some other economic, public health or even political event.

DM: Are mandates that are being stretched or is it the interpretation of mandates that have gotten more extensive? Once something is stretched, can it be taken a bit further and then still a bit further? At what point do they get beyond the basic ideas that the framers of the central bank concept envisaged? 

CPS: That is certainly the argument that proponents of what I call “central bank activism” would make. We have these broadly worded statutes. We can put anything under this big tent. Ultimately, you have to fall back on fundamental principles of rule of law and how a democratic society is organized. Of course, we don’t want to overly constrain the Fed. Congress wanted the Fed to do its core historic job, especially the crisis-fighting role. But there must be limits. The Fed’s mandate can’t be stretched by society putting new demands on the Fed, or components of society exerting pressure on the Fed to solve every economic problem of the day. That is not the role of the Fed.

Exploiting the language in the Federal Reserve Act to serve various ends that takes the Fed outside of its legal and historic role, that is where we really have to stop and think. Just because there is an important issue on the horizon doesn’t mean it’s a job for the Fed. Where do you draw the line? Trade, immigration, issues of relations with China, just to name a few? The Fed can’t take all those things on, not just because it doesn’t have the legal authority but because it doesn’t have the resources.

At the end of the day, it’s a big question for American society to wrestle with. I don’t think this country has much appetite for central planning by central banks. Do we want a central-bank leviathan? I think many people would answer that question “no.”

DM: Sure, there are advantages to Congress saying “go this far and no further.” But Congress isn’t exactly renowned for political courage. Isn’t it more convenient to just let the Fed do these things? Central banks can act quickly. What’s wrong with that?

CPS: I get asked about gridlock a lot. In a world where Congress can’t, or won’t, act in a sufficiently expedient way, should the Fed act on its own, take matters into its own hands? I firmly say “no.” There are crucial rule of law issues at stake in subscribing to this lets-go-around-the-gridlock view. Our agencies and central bank are creatures of statutes, so they only have what powers our elected representatives give them. If the American people want the Fed to do something more, like proactively mitigate climate change, proactively mitigate inequality, then they should turn to their democratically representative institution to revise the Federal Reserve Act.

The risk of boundary-pushing interpretations is that it can erode the integrity of the institution. It will make people question whether the Fed’s independence has been compromised. Is it reacting to political pressure or certain segments of society? How can we really know what society’s consensus is if we are not going through our elected institutions? People will start to question the Fed’s authority. The Fed is a body of unelected technocrats that shouldn’t be making value judgments about which issues to address in society, how to do so, with what resources and at what pace.

DM: Does this explain why Fed leadership roles have become so contentious? Alan Greenspan was almost elevated to a deity. In 2006, Ben Bernanke was confirmed by a voice vote in the Senate. Bernanke’s second vote in 2010 was much tougher, as was Janet Yellen’s in 2014. Powell had an easier time in 2018, but he has high-profile opponents now. Do people realize that the best chance they have of influencing policy is through personnel? 

CPS: That’s a fair assessment and an unfortunate development. It’s a reflection of the degree to which the Fed is being pulled into these other issues that are outside its technocratic wheelhouse of monetary policy and what should be relatively objective decisions in regulation, like capital requirements, for example. More subjective decisions about distribution or social policy, we typically think are for the legislature and the executive.

Fed appointments will potentially continue to become more contentious because these questions that fall outside the Fed’s mandate are ultimately polarizing questions. I have done some empirical research with a co-author on Americans’ opinions about whether the Fed should tackle other problems like climate change, inequality, and the answers more or less line up with the respondents’ confidence in the president or how they get their news (for example through social media). 

So if the Fed does weigh into these other areas — and this is no commentary on the substantive importance of those issues — it very likely will exacerbate, or contribute to, polarization in the U.S. Ironically, that will further entrench gridlock and desires to short circuit the system of separated powers that are our constitution is designed around.

DM: Is it a stretch to think of Fed as a de facto state within a state?

CPS: People have made that argument. I am firing a warning shot across the bow. Society has developed expectations that the Fed can do more than it can legally, or should, from a rule of law perspective. There is a risk that if we continue on this track we find ourselves with a Fed that we are unhappy with because we will feel we have created that leviathan. It’s a risk. I don’t think we are there yet.