RE: Maestro

In Economy on January 19, 2010 at 2:28 AM

Monetary policy independence is being spoken of rampantly in the press: Libertarians have been battling Federal Reserve policy experts, e.g., Ron Paul’s Plan to Audit Fed a ‘Serious Attack’: Mishkin, and Federal Reserve presidents have been taking to the pen, e.g., Lacker Says Threats to Fed Autonomy Imperil Stability and Lockhart on Preserving the Role of an Independent Fed. Maybe it is time for a historical flashback. Enter Maestro by Bob Woodward, the American journalist.

Former Secretary of the Treasury James Baker offers a perfect example of Federal Reserve independence under pressure from the Oval Office, as recounted in Maestro by Bob Woodward, published in 2000. If you have not read it, or it has been a while, it is well worth the read right now. In it, you can catch a real glimpse into monetary-fiscal policy efforts at odds with one another.

Where else can one find James Baker referring to Paul Volcker as a “son of a bitch,” while effectively campaigning to end the reign of one of the greatest Federal Reserve leaders in monetary history?

Some passages around the front of the book are very interesting.

In this first passage, Woodward effectively exposes that Volcker was pressured by the Reagan administration to lower the federal funds rate, auspiciously, before the 1980 re-election vote — explicitly through James Baker, and implicitly through Ronald Reagan.

“After polite preliminaries, Baker began by mentioning the fall election. Reagan was seeking his second term, and Baker was in charge of the campaign.

They didn’t want any tightening, Baker said, referring to interest rate increases. He sounded tough and spoke of the upcoming election with some pride. The theme was “Morning in America,” and Reagan was projecting the image of the caring, optimistic father. Higher interest rates would be off message.

Volcker was a little stunned that Baker would talk about interest rates in such an overt political context. Baker could as easily have signaled their desires in a subtle, less offensive way. The chairman stiffened. The setting, the bald language and the swagger made it certainly inappropriate, even improper. Baker was doing all of the talking. The president wasn’t saying a damn thing. Nothing. Blank. Not nodding, not un-nodding, Volcker noticed grimly. How brilliant. Reagan never said anything, his deniability preserved: I never pressured Volcker. But the president’s presence, sitting there calmly—detached or engaged, no one would ever know for sure, including Baker—gave Baker’s words all the weight in the world.”

Economists call this an attempt at generating a “political business cycle.” Coincidentally, I wrote my masters paper on this subject at Georgia State University – click here.

Later passages, following right on the heals of this section, recall Volcker’s first losing vote in FOMC history, again ushered in by way of Reagan-Baker orchestrating, this time with Baker appointed as Treasury Secretary.

“One of Baker’s early picks for the Fed board was Manuel H. Johnson Jr., his 36-year-old assistant treasury secretary, a former Green Beret intelligence specialist. Johnson had told his boss that he believed interest rates should be lowered, and that the Fed’s interest rate policy should be coordinated with the White House and Treasury.

Soon after Johnson joined the board in 1986, he told Volcker he was expected to vote for an interest rate cut the first chance he got. “I feel compelled to vote for one. It’s needed,” Johnson said. Volcker was appalled, concluding that Johnson had made a deal.

Johnson informed Volcker that there were now four votes, a majority, to reduce interest rates. “I’ll defer to how you want to do it,” he told the chairman. “I’ll defer to your leadership.”

At this time, Volcker was opposed to a cut because he was worried about new inflation. “Is Baker pressuring you to do this?” Volcker asked, putting his feet on his desk and lighting a cigar.

“I’m sure Jim Baker supports this,” Johnson replied. “He knows how I’ll vote.”

On February 24, 1986, Johnson and three other board members took charge and voted 4 to 3 to lower the discount rate. Volcker found himself in the minority for the first time.”

Anyone who understands “The Phillips Curve” correctly, understands the collective reservation a majority of economists share toward rupturing Federal Reserve monetary policy independence, as esoteric a concept as it sounds.

In the end, Bob Woodward’s book represents a timely read on the subject of Federal Reserve independence.


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