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ABSTRACT
The Financial Crisis that started in 2007 ushered in new responsibilities for central banks, particularly for what is termed ‘macro-prudential policy’, or MPP. The goal of this policy is to monitor and contain overall risk in the financial sector. Implementing MPP, however, carries the potential for distributional conflict with the largest financial firms and the politicization of central bank policy. In light of this risk, this essay analyses the institutional implications of MPP for a leading central bank, the US Federal Reserve. Specifically, how will MPP affect the autonomy of the Fed to set the policy it thinks right? The analysis is based on interviews with financial regulators, including Fed staffers and policymakers, and with journalists who report on financial regulation. It is also informed by a case study of the ‘Volcker Revolution’ in monetary policy. Based on these sources, I identify the factors that contributed to Fed autonomy in the conduct of monetary policy during the Volcker Revolution and assess the extent to which those same factors hold for MPP. I close with an assessment of what MPP means for the new political economy of the Fed in particular and developed world central banks more broadly.
ACKNOWLEDGEMENTS
An earlier version of this paper was presented at the conference on ‘Governing the Fed: The Politics of Economic Policy’, Oxford University, 5 October 2012. I am grateful to Mark Schneider, Akshay Menon and Long Tran for research assistance and to Alexandra Cirone, Desmond King, Matias Mednik, Guillermo Rosas, David Rueda, Hugh Sansom, Cheryl Schonhardt-Bailey, Michael Schwam-Baird, Meredith Wilf, conference participants and others for their comments and suggestions.
Notes
1 From this point on, the phrase ‘the Federal Reserve’ or ‘the Fed’ will be used to refer to the Federal Reserve System comprising the Board of Governors and regional Reserve Banks.
2 For an explanation of the diffusion of MPP concepts, see Baker Citation(2013). For a discussion of changing mandates at the Fed and the need for new policy tools, see Reinhart and Rogoff Citation(2013).
3 This attribute is distinct from the concept of bureaucratic discretion, see Carpenter Citation(2001).
4 See Adrian and Shin Citation(2010), Borio Citation(2011), Goodhart Citation(2010).
5 This is analogous to what Elliott et al. (Citation2013) refer to as ‘cyclical MPP.’
6 See joint comments from the American Bankers‘ Association, the Financial Services Round Table and the Securities Industry and Financial Markets Association (SIFMA) on ’Proposed Supervisory Guidance on Regulatory Capital,' at: <http://www.federalreserve.gov/SECRS/2013/October/20131030/R-1460/R-1460_102113_111426_419056220901_1.pdf>.
7 Leverage Ratios – Leavened: Regulators go easy on Europe's Overstretched Banks,' The Economist, 18 January 2014.
8 These interviews were anonymous and designed to yield personal rather than official views. In order to maintain anonymity, I do not include identifying descriptions, including agency of employment. I spoke with staff members at the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC) in addition to staffers at the Board of Governors, two of the Regional Reserve Banks of the Federal Reserve System and the Office of Financial Research. I also spoke with a number of former Fed Governors.
9 See Ron Paul's bill, HR 1207, the Federal Reserve Transparency Act introduced in February 2009. The bill threatened Fed independence through its provisions for wider monitoring and oversight.
10 See <http://www.federalreserve.gov/newsevents/testimony/bernanke20090724a.htm> for Chairman Bernanke's testimony and ‘The Right Reform for the Fed,’ by Ben Bernanke, Washington Post, 29 November 2009.
11 This argument also assumes that the Fed is the appropriate macro-prudential supervisor. For discussions of the institutional location for macro-prudential policy, see Blinder Citation(2010), Feldstein Citation(2010) and Goodhart Citation(2012).
12 The House Committee is formally the House Financial Services Committee while its Senate analog is the Committee for Banking, Housing and Urban Affairs but both are informally described as banking committees. Dodd-Frank was ultimately passed in July 2010.
13 The only institutional change for banking regulation with Dodd–Frank was the formal closure of the Office of Thrift Supervision (OTS) and the roll-in of its functions and personnel into the OCC. The largest general institutional change within Dodd-Frank was the creation of the Consumer Financial Protection Bureau.
14 The Dodd-Frank Act of 2010 did, however, create a new agency, the Office of Financial Research (or OFR), as a bureau of the Treasury, charged with data collection and analysis for the financial system as a whole.
15 The 10 voting members of the FSOC (there are five non-voting members) are the Secretary of the Treasury, who chairs the Council, the Comptroller of the Currency, the chairs of the Federal Reserve, the Securities and Exchange Commission (SEC), the FDIC, the Commodity Futures Trading Commission (CFTC), and the National Credit Union Administration Board, and the Directors of the Bureau of Consumer Financial Protection and the Federal Housing Finance Agency, plus an independent member with insurance expertise.
16 The Treasury's ‘Green Book’ report of 2009 describes SIFI's as ‘Tier 1 Financial Holding Companies’ or FHCs, but the import is equivalent.
17 See Section 113, Dodd-Frank Act.
18 The broader literature on delegation and autonomy stresses both ex ante and ex post political control, with ex ante influence via the appointment of personnel and ex post control exercised through oversight and the potential for legislative override.
19 See Carpenter Citation(2010a) for a deep, qualitative account of the development of expertise at the FDA, and Kiewiet and McCubbins Citation(1991) on different aspects of the delegation decision. Huber and McCarty Citation(2004) and Gailmard and Patty Citation(2007) consider the incentives for agencies to invest in expertise in order to increase their autonomy.
20 Carpenter (Citation2001: 5).
21 In the latter case, divided government increases the attractiveness of agency independence for Congress because it ensures that the administration cannot directly control policy.
22 See canonical work by Stigler Citation(1971) and Peltzman Citation(1976).
23 The primary legislative acts governing the Fed are the Federal Reserve Act of 1913 and the Banking Acts of 1933 and 1935, the last of which was particularly important for the composition of the Federal Open Market Committee.
24 There is an extensive political science literature on political influences in Fed policy-making. See Mayer Citation(1990) for references and Todd Citation(2012) and Meltzer Citation(2009b) for examples of different types of pressure.
25 That the Volcker Chairmanship marked a distinct break in Fed policy is confirmed by econometric analyses of structural breaks in monetary policy, see Duffy and Engle-Warnick Citation(2006) and references therein.
26 The FOMC is the key decision-making body on monetary policy in the Fed and is composed of the seven members of the Federal Reserve Board of Governors (including the Chair) and all 12 Presidents of the Federal Reserve Banks. Only five of those Presidents have voting rights at any time, with the President of the FRBNY having one vote and the four remaining votes rotating among the other Presidents.
27 Bailey and Schonhardt-Bailey Citation(2008) and Silber Citation(2012) separately describe how Volcker presented the switch in policy to FOMC members as an instance of ‘credible commitment’ rather than as a monetarist approach per se. In achieving agreement on a new approach, Volcker was, however, aided by a growing consensus within the economics discipline that inflation should be viewed as a monetary phenomenon. Meltzer Citation(2009b) suggests that Modigliani's address to the 1976 AEA meetings marked the emergence of this new consensus.
28 The Fed had conducted ‘open market operations’ since 1922, when it was first used as a means of maintaining asset levels at Reserve Banks (Timberlake, Citation1993: 261).
29 See Woolley (Citation1984: 104) on the political arguments for adopting the aggregates approach.
30 See Vincent Reinhart, ‘Geithner and Bernanke are Wrong About the Fed’, The American, 31 March 2010. Available at ≤http://www.american.com/archive/2010/march/geithner-and-bernanke-are-wrong-about-fed-power/article_print>, accessed 20 August 2012.
31 One individual indicated that this was because a post at the Fed enabled a young economist to maintain the option of returning to academia whereas employment at other banking agencies generally precluded any such return.
32 Ryan Grim, ‘Priceless: How the Federal Reserve Bought the Economics Profession’, Huffington Post, first posted 23 October 2009, accessed at ≤http://www.huffingtonpost.com/2009/09/07/priceless-how-the-federal_n_278805.html> on 22 February 2013.
33 Kettl (Citation1988: 55) describes how Secretary Morgenthau attended a meeting of the FOMC and said, ‘Now I never threaten’, but added that he hoped the FOMC would ‘use the mechanisms which you have and give us an orderly market, or the government will and that's the whole story’.
34 See Schonhardt-Bailey Citation(2013) who emphasizes that criticism of the Fed has been reflected in Congressional language about the institutional structure of the Fed and changes to it. More dependent central banks have been characterized by political quiescence (and direct political control) but rarely if ever do governments seek to undertake monetary operations themselves.
35 The OFR was established specifically to collect and analyze data on the financial sector but has faced delays in its operation with its Director confirmed only in early 2013.
36 This was Patrick Parkinson, who was appointed in October 2009.
37 For example, the Federal Financial Institutions Examination Council works to ensure that bank exams are consistent across the examining bodies.
38 See Shahien Nasiripour, ‘US Regulator Demands Stricter Bank Loan Ratio’, Financial Times, 5 February 2013 and Gretchen Morgenson, ‘A Roadblock to Brawny Bank Reform’, New York Times, 4 January 2014.
39 Carpenter Citation(2011) also points to the role of a small number of financial firms that dominate the sector.
40 Lobbying was also seen from the American Bankers Association, the Securities Industry and Financial Markets Association (SIFMA) and the Financial Services Roundtable, see Jesse Hamilton, ‘Basel III Start Delayed as Bank Regulators Review Comments’, Bloomberg, 9 November 2012.
41 See opensecrets.org. In order to identify large firms, I use data from Compustat to isolate the financial sector companies that are ‘large’ using different metrics, either having a value of equity of more than $5 billion (the criteria used by Acharya et al., Citation2012), having total assets of more than $50 billion (the threshold used by the FSOC to determine whether a bank holding company is a SIFI), or having total assets of more than $100 billion (which was the threshold used for the original round of SCAP stress tests). Under the broadest criteria, there are approximately 100 US companies that can be described as large financial firms, and about another 20–30 foreign firms with operations in the US. In identifying the interest groups that represent the largest firms, I rely on interview sources and the record of comments made from different interest groups.
42 Lobbying amounts are given in real, US Dollars with 2009 as the base year.
43 Those firms and groups are the American Banking Association, Citigroup, the Financial Services Roundtable, J.P. Morgan Chase, SIFMA, and Wells Fargo.
44 Eric Lipton and Ben Protess, ‘Banks'Lobbyists Help in Drafting Financial Bills', New York Times, 23 May 2013.
45 Sarah N. Lynch, ‘Wall Street Regulators face budget crunch under new spending deal’, Reuters, 14 January 2014.
46 In the language of Kalt and Zupan Citation(1984), will Members of Congress vote on ideological grounds rather than as pure representatives of concentrated, constituent interests or campaign contributors?
47 Thus this account differs in a key respect from Carpenter's Citation(2010b) portrayal of strategic industry reaction to the financial crisis. Whereas Carpenter stresses the role of partisan veto points in obstructing more radical reform, I highlight the absence of meaningful partisan or ideological divide on financial risk as a factor contributing to vulnerability to industry capture following the enactment of Dodd-Frank.
48 The Terminating Bailouts for Taxpayer Fairness (or TBTF) Act.
Additional information
Notes on contributors
Lucy M. Goodhart
Lucy M. Goodhart is a visiting scholar at the Weatherhead Center for International Affairs, Harvard University. Her research spans issues within international and comparative political economy with a focus on the role of central banks and banking regulation within the advanced, industrial economies.
