The fuss about the bank
or How I learned to stop worrying and love open market operations
President Trump is calling on the Federal Reserve to reduce interest rates. As none of us will soon forget, the Federal Reserve forced interest rates steeply upwards to combat rising inflation caused by supply chain issues and profligate federal spending that emerged in reaction to the Pandemic. The Fed's quick and prudent action is credited by many with having staved off the dire prospect of runaway inflation, decreasing the rate from a high topping 8% in 2023 back down to a pedestrian mid-2% by the end of the Biden Administration, astonishingly without instigating a recession in the process.
But a decrease in inflation does not mean a decrease in prices. Inflation is the rate of increase in prices in the economy, so when the Fed brought the inflationary beast to bay, it only ameliorated the pace of increasing prices. Post-Covid prices are here to stay, and will only continue to go up, albeit at a lower rate going forward.
And so, the deciding issue of the 2024 presidential election became “the price of eggs,” or so we are now told at least. Candidate Trump certainly railed against the cost of “grocery” and in typical fashion declared that he would instantly tame the inflation that had so beguiled President Biden. Just how he would accomplish that or indeed what exactly it would entail was also left characteristically unspecified.
But demanding now that the Fed decrease interest rates is fundamentally at odds with lowering inflation (much less costs). The only demonstrated method of curbing inflation is for the central bank to cool the overheated economy by making borrowing more expensive. Price controls do not work; they only drive the supply of goods and services into the black market where the real price still governs.
Interest rate hikes are strong medicine, however, that inflict significant short term financial hardships on regular people in the interest of the long term health of the economy. Higher rates are received by consumers and businesses alike as a kick when they’re already down. Not only are the costs of goods and services going up, but now cash itself becomes more expensive.
For this reason, the membership of the Federal Reserve Board is insulated by law from the headwinds of popular opinion. Board members can only be fired by the President for cause. As a result, they can make the unpopular decision to raise rates and keep them high until inflation returns to normal levels. They are able to weather the storm of public backlash without fear of being removed from office for making the hard calls.
Stagflation
In the late 1970s, the American economy was suffering from “stagflation,” a phenomenon previously considered by economists to be theoretically impossible, or at least highly improbable. Under stagflation, a portmanteau of stagnation and inflation, the economy suffers both high inflation and high unemployment. Stagflation at the end of the 1970s was initiated in part by global price shocks likely related to oil crises in 1973 and 1979.
According to traditional economic theory, unemployment and inflation are inversely correlated, as shown by the Phillips Curve. Normally, inflation is caused by too much activity in the economy, a demand-side problem. Increased economic activity should stimulate employment. Thus as inflation rises, unemployment should be falling.
Stagflation, however, was sparked by supply-side crises and price increases did not necessarily reflect greater economic activity. Indeed, high supply prices presumably act as a barrier to further economic activity, contributing to the stagnation part of stagflation. In the case of the 1970s stagflation, supply side costs rose in large part due to drastic increases in oil prices during that decade.
In 1979, President Carter appointed Paul Volcker as the new Chairman of the Federal Reserve. In The Crisis of Capitalist Democracy, Judge Posner describes how Chairman Volcker licked inflation:
A famous example of how the Federal Reserve can influence long-term interest rates through open market operations is its breaking of the inflation of the late 1970s. Inflation was running at an annual rate of 12 percent when Paul Volcker was appointed Chairman of the Fed in August 1979, and the federal funds rate was 11 percent. The Fed pushed it up to 20 percent in 1981. The prime-loan bank rate, 12 percent in August 1979, followed the federal funds rate up, reaching 21.5 percent in 1981. By 1983, inflation had fallen to 3 percent.
But in doing so, the Fed pushed the American economy into a recession, beginning in July 1981 and continuing until November 1982. The Federal Reserve's tough love was not popular. Farmers protested and car dealers sent Volcker coffins filled with the keys to their unsold vehicles. More plaintively, Volcker received letters from regular people describing how they could not buy a home despite years of saving, due to sky-rocketing mortgage rates.
In Congress, the Fed took fire from both sides of the aisle. The central bank was accused of "destroying the American dream" by one Congressman and another threatened to introduce articles of impeachment against Volcker. Even the Secretary of the Treasury got in on the act, criticizing Fed actions for instigating a "severe recession." But Volcker held the line, despite what he described as "some unusual public communications from the Secretary of the Treasury."
Volcker's intestinal fortitude in the face of criticism was crucial in breaking the back of runaway inflation, as Judge Posner observes:
We know from the experience in 1979 - 1982, that high interest rates engineered by the Fed to stop inflation, can co-exist with both high inflation and high unemployment - a politically unpopular combination that helped Reagan beat Carter in 1980. For high interest rates do not automatically stop inflation in its tracks. If people think that the increase in interest rates is temporary, and that inflation will continue, they will keep on borrowing and spending because they will not think the high interest rates are "real" - they'll think they'll be able to pay back their loans with cheap money. In that event, the ratio of money in the economy to goods and services will not diminish.
Thus, it was not just high interest rates alone that curbed inflation in the early 1980s, but also the perception by people that the Fed would stay the course regardless of countervailing political winds.1 Indeed, Posner argues that it was at least partly "Paul Volcker's forceful personality and commanding presence (he is six foot eight), which helped convince the nation that he was serious about stopping inflation no matter at what cost." If economic actors do not believe that high interest rates are here to stay, they will not change their behavior.
The executor of Humphrey’s estate
As part of the ongoing DOGE-ification of the federal government (in reality a patent and blundering effort to reintroduce a spoils system in federal employment not seen since the nineteenth century), President Trump has fired without cause certain members of the National Labor Relations Board and the Merit System Protections Board. Like the Federal Reserve Board of Governors, commissioners on the NLRB and MSPB enjoy fixed terms and cannot be fired under law by the President except for good cause.
But, as I have described, this Administration adheres to the Unitary Executive Theory of the Constitution, which holds that because Article II vests the President solely with the "executive power," all subordinate officers and employees in the executive branch must serve at the pleasure of the President and be subject to removal by him without cause. Any and every congressional statute vesting an executive branch official with for-cause removal is unconstitutional.
The U.S. Supreme Court held otherwise in a 1935 case called Humphrey's Executor v. United States. In that case, FDR fired Humphrey, a member of the Federal Trade Commission. Humphrey had been appointed by Coolidge in 1925 and then Hoover had re-upped him for a second term in 1931. Humprey was a gadfly that did not believe in the FTC's mission. He thought that the commission was a burden on American business and opposed its enforcement actions.
Roosevelt predictably found Humphrey insufficiently ethusiastic about the New Deal. The President twice asked Humphrey to step down voluntarily. When Humphrey refused, FDR just fired him outright in October 1933. Problem was, the FTC was (and is) another statutorily independent agency whose commissioners were insulated from presidential firing except for "inefficiency, neglect of duty, or malfeasance in office." FDR had made no bones about his reason for axing Humphrey; the motivation was purely political.
When Humphrey passed away in February 1934, the executor of his estate sued the government seeking backpay because FDR's political firing had violated federal law. The Supreme Court held in favor of Humphrey's executor 9-0 in an opinion by Justice Sutherland that found the removal restrictions on FTC commissioners did not violate the Constitution.
The court distinguished between executive branch officers whose duties were purely executive in nature and those with "quasi-legislative" or "quasi-judicial" powers. Executive-only employees were subject to at-will employment and could be removed whenever the President decided.
But Congress could qualify presidential removal of quasi-legislative and quasi-judicial officers by requiring good cause. Since the FTC promulgated administrative rules (a legislative function) and adjudicated administrative cases (a judicial one), Congress could impose removal restrictions and the President's firing of Humphrey for purely political reasons was illegal.
The rule in Humphrey’s stood for many decades without question by Republican and Democratic presidents alike. In recent years, however, the high court, influenced by the conservative legal movement's advocacy of the Unitary Executive, has limited the holding in Humphrey's Executor. In Seila Law, LLC v. Consumer Financial Protection Bureau, for example, the Court in a 2020 opinion by Chief Justice Roberts held that the federal law restricting removal of the director of the CFPB violated the separation of powers.
The court distinguished, but did not explicitly overrule Humphrey's, because that precedent had characterized the 1930s FTC as "exercis[ing] no part of the executive power." In addition, it was headed by a bipartisan board of experts. The CFPB, on the other hand, is led by a single officer who exercises significant enforcement powers. The Chief Justice thus concluded that the CFPB director is an executive official who must be subject to at-will presidential removal.
It's true that the CFPB has significant enforcement authority. But it also promulgates regulations and makes the final call on adjudications recommended by administrative law judges. Conversely, the 1930s FTC was empowered to enforce federal laws prohibiting unfair trade practices.
I’m at a loss to explain exactly what distinction the Chief Justice was making in Seila Law. He seemed to emphasize the difference that the FTC in Humphrey’s was composed of a multi-member board while the CFPB is headed by a single officer, which I suppose feels a bit more … executive-y.
If the distinction between Humphrey's and Seila Law turns on multi-member versus single-headed agencies, the court's shadow docket decision a week and a half ago in Trump v. Wilcox is hard to understand. The court granted the government's request to stay lower court orders reinstating the NLRB and MSPB commissioners fired by Trump. As Michael Dorf observes, “[t]here are no salient distinctions between the NRLB and MSPB, on the one hand, and the Federal Trade Commission (FTC) as issue in Humphrey's." He consequently concludes that with Wilcox, the court has "effectively" overruled Humphrey's.
Bizarrely, the court's unsigned Wilcox opinion does not even mention Humphrey's, much less explain why the NLRB is different from the FTC in a constitutionally significant way. Dissenting with Justices Sotomayor and Jackson, Justice Kagan calls the court's failure to address Humphrey's "nothing short of extraordinary." Like me, the dissenting justices cannot divine the majority's distinction between Humphrey's and Wilcox.
Justice Kagan speculates that "[m]aybe by saying that the Commissioners exercise 'considerable' executive power, the majority is suggesting that they cannot fall within the Humphrey's 'exception.'" But, she points out, "if that is what the majority means, then it has foretold a massive change in the law - reducing Humphrey's to nothing and depriving members of the NLRB, MSPB, and many other independent agencies of tenure protections."
Nevertheless, the majority assures us that the independence of the Federal Reserve at least is not a concern. The Fed, they say, "is a uniquely structured, quasi-private entity that follows in the distinct historical tradition of the First and Second Banks of the United States." So in essence, the majority claims that the central bank is sui generis, for historical reasons unmoored to any text, history, or structure (or even mention) contained in the Constitution itself.
For his part, the President is at his Trumpiest on the question. Sure, he could fire Chairman Powell. But he wouldn't do such a thing! Or maybe he would…?
It’s an interesting question why interest rate hikes, which target demand in the domestic economy, should have ameliorated the effects of international supply issues. Perhaps the Fed’s efforts just kept the American economy afloat through the storms of oil shocks until supply prices came down on their own. On the other hand, some argue that oil prices were merely the straw that broke the camel’s back. The roots of inflation were loose monetary policy and federal spending coupled with over regulation of domestic industry. In that telling, it was deregulation plus tighter fiscal and monetary policies during the Reagan era that ultimately rebalanced the American economy.