In June 1971 Arthur Burns, then chairman of the Federal Reserve, sent U.S. President Richard Nixon a nine-page letter in which he summed up the country’s economic challenges: “namely, an inflation feeding on itself at a time of substantial unemployment.” Burns told the Republican president, who had nominated him to the Fed and for whom he previous served as an adviser, that “our monetary and fiscal policies have not been working as expected.”
Over the next year, in the run-up to the 1972 election, Burns doubled down on those policies, while the president instituted price and wage controls. Nixon won re-election, but the damage to the U.S. economy was severe. Consumer prices surged nearly 10 percent in 1973, the United States dipped into recession and it took another decade, and Paul Volcker’s unbending efforts as Burns’ successor at the Fed, to tame inflation.
The episode nicely highlights the importance of central bank independence at a moment when, not for the first time, a president’s urge is to meddle in the Fed’s affairs. Even though the economy is humming along, President Donald Trump has publicly criticized Burns’ contemporary successor, Jerome Powell, for the Fed’s tightening of monetary policy over the past year. Just weeks ago, ahead of the Federal Open Market Committee meeting, he called for a cut in interest rates. The Fed did not comply.
I wouldn’t have known about Burns’ letter if it hadn’t been dug out of the archives, copied and handed out by former U.S. Secretary of State George Shultz at a monetary policy conference at Stanford’s Hoover Institution last week. It’s an intriguing choice by the 98-year-old Shultz, both for its timing and content and because of his role in helping Nixon pressure Burns into a series of unfortunate policy decisions. At the time of the epistle’s drafting, Shultz served as Nixon’s director of the Office of Management and Budget.
Burns is now widely regarded as having caved too easily to the Nixon administration’s bullying. In a 2006 paper published in the Journal of Economic Perspectives, University of Delaware professor Burton Abrams combs through recordings from the Nixon White House to show how the president, along with Shultz, exerted pressure on Burns to keep policy rates low. “War is going to be declared if he doesn’t come around some,” Nixon tells Shultz in February 1972.
At the time, the American economy, having just come out of a recession in 1970, wasn’t in great shape. Inflation ran nearly 6 percent that year, and unemployment hovered around 6 percent too, the highest in a decade. Nixon was understandably exercised going into his re-election test. Fast forward to this year and the unemployment rate dipped to 3.6 percent in April, inflation is below even the Fed’s target of 2 percent, and the S&P 500 Index hit a new high earlier this month. All of which makes Trump’s needling the Fed far more bewildering than Nixon’s.
Besides goading Powell and the Fed on Twitter, Trump tried to shoehorn two unqualified, partisan candidates into open positions on the central bank’s board. Many Fed loyalists at the Stanford monetary policy confab judged it an aggressive attempt to politicize the central bank. Neither Herman Cain nor Stephen Moore, the aborted potential nominees, were present at the conference, which John Taylor, the George P. Shultz Senior Fellow in Economics, pulls together each year. And their names, as far as I can recall, were never uttered from the podium. But they were present in spirit.
“One observes the casting of prospective nominees to our central bank in the last decade as either ‘with us’ or ‘against us.’ This is a troubling development,” Kevin Warsh told the assembled monetary nerds. That’s a strong statement coming from a Republican, a former adviser to George W. Bush, an ex-governor of the Fed and Trump’s second-choice pick after Powell to run the central bank.
There was still plenty of debate about how the Fed should go about its business. Taylor, after all, is the leader of a conservative school of thought – including a rule that bears his name – that suggests monetary policy should follow a formula. By this thinking, central bankers exercising discretion over policy leads to mistakes which ultimately could damage Fed independence.
Where I could find no disagreement between so-called hawks or doves, however, was in the notion that the central bank should execute its duties with as little regard as possible to the whims of the political class. In a follow-up chat for a Reuters podcast, “The Exchange,” Taylor was diplomatic, saying “there will always be differences of opinion” on monetary policy. He then praised some of Trump’s economic policies, including last year’s tax cuts.
That’s to be expected of a lifelong Republican and a Treasury official under President George W. Bush. Taylor was also among the people considered by Trump for the Fed chair, alongside Warsh and Powell. But a formula is a formula, and he’s not in the rate-cut camp. When asked where, according to his eponymous rule, he thought the equilibrium rate of interest (roughly corresponding to the Fed funds rate) should be, he said closer to 3 percent than the current range of 2.25-2.5 percent.
An academic, of course, will have an easier time arguing about the right price of money than an actual central banker who must face political and financial-market pressures every day. Nonetheless, it’s clear that Taylor and others on the same political team as the president – including Shultz, who fiddled with Fed independence nearly half a century ago – know that a politicized Federal Reserve is a bad idea.