Link to the post on Greg’s blog

Greg Shill is the expert I turn to for a better understanding of legal issues surrounding monetary policy. He is a fellow at New York University Law School and is on Twitter here. This is the first of what I hope are many guest posts by Greg. This one appeared first on his own blog on December 4, 2014. Thanks to Greg for allowing me to reproduce it here. Greg’s words follow: 

Many in the Federal Reserve – both the Board of Governors in DC and the reserve banks around the country – have come to view low inflation as the main threat to the economic recovery. Fed Chair Janet Yellen has repeatedly voiced this concern, which was detailed today by Chicago Fed chief Charles Evans in an interview with the New York Times. The Bank of Japan and the European Central Bank have recently warned of the same problem. Those institutions, and Japanese Prime Minister Shinzo Abe, have staked their reputation on the power of monetary policy to stimulate economic growth, and there are growing calls in and outside the Fed for the US central bank to do more.

The basic problem these institutions are trying to address is that with inflation expectations low – and they have been very low since 2008 – firms and individuals have little incentive to invest or take other economic risks, which means the virtuous cycle of spending and hiring leading to more spending and hiring hasn’t had an opportunity to get rolling yet.

I’m interested in the scope of the Fed’s legal authority to address this collective action problem through so-called unconventional monetary policy, which has come to be defined as the use of unusual monetary measures to stimulate demand. I will soon be writing more about these legal questions here and at Miles Kimball’s blog, Confessions of a Supply-Side Liberal. Miles, an economist at the University of Michigan, has written extensively on how to combat the so-called Zero Lower Bound problem, which is when the economy is stuck in a rut for the long term and the Fed can’t do more to stimulate lending (or inflation) through its conventional policy channels because it can’t take interest rates below zero.

The question I’ll be looking at is, how far can the Fed in unconventional policy go beyond what it’s already done. The Fed’s most prominent use of unconventional policy post-crisis took the form of the three consecutive rounds of “quantitative easing,” during which the bank bought US government bonds and government-backed asset-backed securities (Fannie and Freddie mortgage-backed securities (“agency MBS”)). Many economists believe quantitative easing served as a major stimulus to the economy and was particularly helpful given the inadequacy of the 2008 and 2009 fiscal stimulus measures. However, many “dovish” economists and Fed policy makers, like Evans, would like to see the bank do more.

When I began to look at the legal dimension of monetary policy – after all, that policy is conducted pursuant to a legal mandate – I was surprised to find very little in the way of scholarship or (publicly-available) policy guidance. Until recently, Fed officials and outside observers have strongly suggested that the Fed lacked the authority to expand the bank’s QE program beyond US government bonds and agency MBS. While Fed officials haven’t revised that view publicly, one might reasonably begin to question whether they doth protest too much. In testimony at the ongoing trial of former AIG CEO Hank Greenberg’s lawsuit over the Fed’s bailout of AIG, Fed officials have recently, for the first time, acknowledged the existence of something the NY Fed actually refers to as the “Doomsday Book,” which is a multi-hundred-page book kept in the basement of the NY Fed that outlines the legal parameters of what the bank can do in the event of a crisis (!). The Fed has thus far avoided having to turn this over, so we can only speculate about what it contains.*

As I will discuss in upcoming posts, my initial review of the sources of law governing the Fed (about which very little has been written) suggests that the bank has significantly more monetary policy discretion than is commonly assumed. I personally believe this expansive power is a good thing: the Fed is charged by statute with a dual mission of promoting full employment and “price stability,” and given the importance of that mandate – as illustrated by the continuing weakness of the economy and the extraordinary human suffering it’s caused – it’s important that those terms have real meaning and not be aspirational only. (“Price stability” has normally been taken to require monetary tightening to keep the economy from overheating, but if the Fed’s inflation target is not being met there’s no reason the same term couldn’t permit loosening in order to stimulate the economy.) Further, Congress gave the Fed a broad mandate in the Federal Reserve Act of 1913; for good reasons, it chose not to set monetary policy legislatively. Given how broadly that statute is written, it’s hard not to see the delegation as a deliberate choice, and one that favors a functional interpretation of the statute (literal interpretations of the Federal Reserve Act are often not fruitful exercises).

So those are my (dovish) priors. If one is an inflation hawk, however, there’s even more reason to want a clearer sense of the legal scope of the Fed’s authority. Presumably a hawk would want to restrict the Fed’s authority to stimulate the economy and would want to know where the lines are that circumscribe the bank. Burnishing his hawk credentials, Texas Governor Rick Perry once famously branded then-Fed Chairman Ben Bernanke’s monetary policy “treasonous” and rhapsodized about Texas-style dangers to Bernanke’s safety if he set foot in the state. So it seems it’s safe to say that this subject appeals to cowboys, economists, and policymakers alike, as well as legal academics.

*Interestingly, officials have conceded that the Fed broke the law a few times during the crisis, to facilitate bank rescues (essentially without legal consequences). So there’s even some question about the enforceability of the constraints on the Fed that do exist.

Note: Mike Sankowski told me on Facebook: “Over at monetary realism Carlos R Mucha Cullen Roche and JKH talk about these legal constraints frequently.”