This is the second guest post by Greg Shill, a lawyer and fellow at NYU School of Law, on the legal scope of the Fed’s powers in the area of unconventional monetary policy. His work focuses on financial regulation, corporate law, contracts, and cross-border transactions and disputes, and his most recent article, “Boilerplate Shock: Sovereign Debt Contracts as Incubators of Systemic Risk,” examines the role of financial contracts in the Eurozone sovereign debt crisis. (His first guest post was “So What Are the Federal Reserve’s Legal Constraints, Anyway?”)
As a longtime follower of Miles’ work, it’s an honor and privilege to write for his blog and to put my ideas in front of his diverse and sophisticated audience. So, thank you, Miles, and your devoted readers.
I. For the past several years, the Federal Reserve has used many levers to stabilize and stimulate the economy. One of its most controversial has been the use of so-called unconventional monetary policy, chiefly three rounds of quantitative easing (or QE, beautifully explained in this clip) from 2008 to 2014. Although the wisdom of these policies has been widely debated, the Fed’s legal range of action largely has not. In fact, as I have noted previously, policymakers and observers have been remarkably quiet about the scope of the Fed’s legal authority to conduct unconventional policy, and when they do describe it they often offer timid visions of the Fed’s powers.
Economists and other observers have often urged the Fed to do more to juice a recovery that was, until recently, broadly disappointing. These proposals have included not only calls to cut interest rates and launch quantitative easing in the first place (both of which the Fed did), but to target higher inflation, introduce electronic money, conduct direct monetary transfers to the public, extend QE beyond its wind-down in October 2014, and expand the range of assets eligible for purchase under QE. The Fed of course did none of those more ambitious things, and today, with QE finished and policy normalizing, defining the legal limits on the Fed’s monetary policy arsenal may feel less urgent. Yet it is a startlingly important question to leave open, given the strong likelihood that the Fed will need to consider aggressive and creative measures in the future combined with the persistent overall weakness in the global economy.
The general question is: in a future recession or crisis, does the Fed have the tools it needs to go beyond what it’s done in the past? This is one of the most important open legal questions in public policy today.
II. Although it is not one of the sexier proposals mentioned above, in this post I will focus on the classes of assets the Fed can buy via quantitative easing. I start there because it’s an area where the scope of the Fed’s legal authority is unsettled, we are getting new data (foreign central banks are experimenting right now), and it seems like a somewhat politically plausible extension of the Fed’s recently retired QE campaign.
Under the Fed’s now-concluded QE program, the bank only bought U.S. treasuries and Fannie and Freddie mortgage-backed securities (“agency MBS”). Several of the Fed’s major overseas counterparts—including the European Central Bank and the Bank of Japan—have embarked on their own QE programs, however, and in some ways they are already looking more ambitious. Japan is buying equities and the Europeans, who launched a massive QE program on Monday, have reportedly considered buying “all assets but gold.” If successful, broader asset-purchase programs like these could make it easier to contemplate an expanded purchase campaign by the Fed down the road.
Except for one minor detail: they are widely perceived as illegal under U.S. law. Former Fed official Joseph Gagnon has lamented that the Fed’s asset purchase authority “is limited by law to the Treasury, agency, and agency MBS markets plus foreign exchange” (emphasis added), and others agree. Gagnon would like the Fed to be able to “buy a broad basket of U.S. equities” (a view to which I am sympathetic), but he and others say that that idea lies beyond the Fed’s legal authority, namely the Federal Reserve Act of 1913.
III. The argument that the Fed has the authority today to buy equities is not definitive, but is stronger than is currently acknowledged. Gagnon, an expert on monetary policy, maintains that “the Fed is not authorized to buy equities,” but to a lawyer, this statement is fraught with ambiguity.
True, the Federal Reserve Act does not expressly authorize the Fed to buy equities. Section 14 of the Act, titled “Open-Market Operations,” enumerates several categories of assets the Fed “shall have power” to buy—they actually extend beyond U.S. treasuries and agencies to include assets like gold, state and local government bonds, and foreign exchange—and equities is not among them.
Yet this does not really establish the outer bounds of the Fed’s authority to buy assets. The mere fact that a government agency lacks express statutory authorization to pursue a given policy does not necessarily render that policy illegal. Assuming no other provision of law forecloses that policy (and here, none does), it just means that to be legal, the Fed’s action would have to find a footing on another source—statutory interpretation, case law, a regulation—rather than the text of the statute itself.
The law provides a doctrine for navigating this type of uncertain administrative agency terrain. Known for the eponymous Supreme Court case, the Chevron doctrine gives us a two-part test for figuring out how much freedom of action federal agencies like the Fed enjoy where their governing statutes are unclear. Although the Federal Reserve Act has never been tested in this way, Chevron would provide some support for a decision by the Fed to buy equities (or, for that matter, private-label MBS).
Under Chevron “Step One,” a court asks whether the statute in question clearly circumscribes the agency’s discretion in a given area. If it does, then there is little analysis for the court to do (the agency either crossed the line or it didn’t), but if it does not, then Chevron “Step Two” applies.
Step Two: where the statute is unclear—in other words, the operative provisions are “silent or ambiguous with respect to the specific issue” at hand—the court asks whether the agency’s action “is based on a permissible construction of the statute.” Chevron v. NRDC, 467 U.S. 837, 843 (1984) (emphasis added).
In the 31 years since Chevron was decided, the case has been interpreted thousands of times and has spawned an entire area of jurisprudence, but the essential question remains the same: was the agency’s interpretation of its own powers “permissible”?
IV. Note that the key question in the Chevron analysis is not whether the agency’s interpretation is the most legally sound or reflects the wisest policy choice. The court treats the ambiguity in the statute as a delegation of discretion by Congress to the agency to interpret the agency’s own powers; the court is only supposed to ensure that the agency reach an interpretation of those powers that is “permissible” (not even “reasonable,” let alone “best”).
Here, the operative statutory provisions are in the Fed’s legal mandate (Section 2A, “Monetary policy objectives”) as well as the open-market operations provision (Section 14). The mandate, which requires the bank to pursue full employment and price stability, is written at a high level; the bank is obligated to “maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates” (emphasis added). These terms are nowhere defined in the statute.
Assuming the Fed wished to begin buying equities, the basic interpretive exercise under Chevron would proceed as follows. We have here two provisions, Sections 2A and 14, that address monetary policy. Section 2A frames the overall objectives of the bank. Section 14 lists several types of assets the Fed can buy in open-market operations to pursue those objectives, but does not purport to restrict purchases to those types. Thus, there is a good argument that the scope of the Fed’s discretion to buy assets under Sections 2A and 14 is unclear, which satisfies Chevron Step One.
Under Step Two, the question would be whether the Fed’s equity buys were conducted pursuant to a “permissible” interpretation of the statute. This turns on questions of statutory interpretation that make even lawyers’ eyes glaze over, but the basic argument is straightforward: Section 2A is worded in such a way as to give the bank considerable discretion to pursue its goals, and Section 14 provides an illustrative, not exhaustive, list of the types of assets the Fed can buy. The Fed could argue that, under the circumstances, fulfilling the purpose of Section 14 requires adding equities to that list, or at least that doing so constitutes a “permissible” interpretation of the statute.
Such an interpretation doesn’t give the Fed carte blanche to buy whatever it wants, only those assets that it realistically thinks are consistent with the statute. So, for example, it could not buy California 10-year bonds, because Section 14(2)(b) expressly restricts the bank’s purchases of state government bonds to maturities not exceeding six months. But a regulation the Fed adopted long ago seems to contemplate the need for wiggle room beyond buying the assets enumerated in Section 14. It provides that the bank may “engage in such other operations as the [Federal Open Market] Committee may from time to time determine to be reasonably necessary to the effective conduct of open market operations and the effectuation of open market policies” (12 C.F.R. 270.4(d)).
This argument is not bulletproof. A second legal doctrine, this one from the area of statutory interpretation, seems to disfavor it: when one or more things in a class are mentioned by name, other members of the same class are implicitly excluded (this is known as expressio unius est exclusio alterius). However, the expressio unius canon does not yield a definitive interpretation either. It should be viewed as a way of getting at the underlying intent of the legislature rather than as a trump card wherever a law contains a list. For example, a sign stating that cars, trucks, and buses are allowed on a given bridge would not be read to preclude motorcycles from using the bridge. In fact, the bar on buying longer-maturity state government bonds suggests that Congress knew how to cabin the scope of the Fed’s authority and intended to specifically restrict the purchase of certain assets, but chose to leave the door open to buying other assets—not only, say, U.S. treasuries of longer maturities, but other classes of assets entirely. And of course if Congress had intended the Fed’s purchase authority to be limited to the assets specified in Section 14, it could have so limited that power. It didn’t.
So, it’s true that the Fed lacks affirmative authorization in the statute to buy equities, but the bank might have that power anyway.
V. Where does this leave us?
Substantively, the Fed probably enjoys greater discretion in unconventional monetary policy—possibly extending to the purchase of equities—than is commonly assumed. But an “equity QE” policy would benefit from an additional legal bulwark: the procedural maze our legal system subjects all litigants to.
A doctrine called standing would make it hard for a private citizen to mount an effective challenge to an equity QE program. This doctrine bars critics from bringing suit unless they can demonstrate a concrete, personal injury that is particular to them and that goes beyond ideological objections or the policy’s social effects. This is hard to impossible to demonstrate in the context of monetary policy. Specifically, a plaintiff seeking to challenge an equity QE program would have to show that he had been injured in some personal and tangible way, not merely that the value of his portfolio had declined (which presumably would also have happened to others pursuing a similar investment strategy). No investor has been able to show this type of injury with respect to the Fed’s aggressive bond-buying QE to date, and there’s no reason to think it would be easier to demonstrate such an injury from an equities purchase program. Combined with a stronger-than-recognized substantive legal justification, this bar on nettlesome litigation should make the likelihood of a successful legal challenge sufficiently dubious to give markets confidence that a Fed program to buy equities could proceed. That said, it would be preferable if the Fed had affirmative statutory authorization, but government frequently must act in a legal gray area.
Politics, of course, is one of the Fed’s most powerful constraints, and in the current political environment, monetary policy doves no doubt see reasons to downplay talk of the bank’s powers. However, hawks and other critics of the current Fed already seem very adept at using the bank as a political piñata without much regard for details like the precise scope of the Fed’s asset purchase authority (see, e.g., Rand Paul’s “Audit the Fed” campaign and legislation). Acknowledging that the bank probably has a wider legitimate range of action than it has used may help underscore the restraint the bank has observed to date. Regardless, it is important that the debate over Fed policymaking be conducted on the plane of policy rather than law. A better understanding of the scope of legal restrictions on the Fed will help facilitate and focus that conversation.