Democracy, Money, and the Central Bank - A Risky Balance ft. Leah Rose Downey

[00:00:07] Leah

You cannot commit credibly over long periods of time to ensuring that policy will serve the interests of one particular group or another. And so the future has to be uncertain because no one is in charge in a democratic system indefinitely.

And so, the idea there is that, you know, democracy can be uncomfortable and can be risky because you have to put your faith in the system that’s going to empower some group of your fellow citizens over time, but you never know which one. And that can be risky. But that’s the name of the game, essentially.

[00:00:50] Intro

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[00:01:45] Niels

For me, the best part of my podcasting journey has been the opportunity to speak to a huge range of extraordinary people from all around the world. In this series, I have invited one of them, namely Kevin Coldiron, to host a series of in depth conversations to help uncover and explain new ideas to make you a better investor.

In the series, Kevin will be speaking to authors of new books and research papers to better understand the global economy and the dynamics that shape it, so that we can all successfully navigate the challenges within it. And with that, please welcome Kevin Coldiron.

[00:01:45] Kevin

Thanks, Niels. And welcome everyone. So, central banks need to be independent. They need to be free from the direct control of politicians. Otherwise we risk monetary policy being used to influence elections. And maybe, over the long term, we risk a descent into very high inflation.

To me, this seems to be one of the few beliefs that’s almost universally held in finance and economics. But is it actually right? Is it healthy for a democracy to allocate so much power to a very small group of unelected people?

Well, we’re going to tackle these questions today and we’re going to base our conversation around a brand new book called Our Money: Monetary Policy As If Democracy Matters. The author and Today’s guest is Dr. Leah Downey.

She’s currently a Junior Research Fellow at St John’s College, Cambridge, and was previously a visiting academic at Sheffield University. She has a master’s degree in economics from the London School of Economics and also a PhD in government from Harvard.

So, Leah Downey, thanks for joining us and welcome to the show.

[00:03:32] Leah

Thanks very much for having me, Kevin.

[00:03:35] Kevin

So, I’m curious about the origins of your interest in democracy, money, and central banks. I mean, is that a question that you arrived at Harvard wanting to study or is this something that you kind of, you know, gradually got interested in?

What were the triggers for you kind of wanting to look into this question?

[00:03:58] Leah

Yeah, it’s a great question. I say there’s kind of two answers. There’s like a long term and a short term answer. The long term answer is that I’ve been interested in sort of economic policy for a very long time.

So, I did my undergraduate degree, I did a dual degree in mathematics and economics and then sort of thought, I’m not sure about sort of economic methodology. So, I did my master’s in economics and philosophy and then eventually ended up in political theory.

So, it was kind of a long way of figuring out that to be an economist of the sort of 18th century moral philosopher style economics, it’s less popular in economics departments these days and more sort of suited to a political theory department. So, I’ve kind of been interested in that topic for a very long time, but had to find my way into the way that I wanted to write about it.

But the shorter answer is that I actually showed up at Harvard thinking a lot about optimization as a form of decision making and looked at actually sort of algorithms, and practical reason, and sort of policy in general, sort of how to make decisions around policy. And that was kind of what I was concerned with early on.

And then I found my way into central banks and as the kind of center of the most important form of policymaking, in my view, almost in the entire government. So that’s what really piqued my interest. And it’s been central banking ever since, really.

[00:05:39] Kevin

And I suspect when most people think about the notion of central bank independence, they imagine it’s kind of this hard coded law, decided based on kind of long debate and well thought through principles. And that may be the case in some places. But in the US your narrative really makes the case that it’s actually been kind of a gradual process of the Legislature kind of giving up power to the central bank, pulling itself out of responsibility for monetary policy. And I wonder if you could just elaborate on that for us, how that kind of happened.

[00:06:21] Leah

Yeah, it’s a really fascinating sort of juxtaposition actually, because on the one hand you’re absolutely right, and I make the case in the book that the way that central bank independence came about, particularly in the US context, is a kind of accumulation of small choices by the Legislature or in many cases sort of non-choices – decisions not to act in particular instances.

And the way I describe this is as an accumulation of all these decisions as a kind of political decision to depoliticize. So, it’s a choice by the political body in that being the Legislature, but it’s a decision to kind of stay out of it, essentially, over time.

And you know, I think the clearest example of this is that most historians of central banks point, in the US context, to the Fed Treasury Accord, the Fed Treasury Report of the early 1950s as kind of the birth of central bank independence in the US, but of course, if you go and read that accord, it doesn’t say the words central bank independence. I mean, it says almost nothing coherent. It was clearly just a kind of, you know, decision between these two bodies to kind of lay off. Like, okay, like truce.

First of all, it wasn’t legislation, and second of all, it wasn’t a clear, as you say, well thought out kind of institutional arrangement. But the juxtaposition is that the theoretical justifications, and what you read about in the textbooks in economics as the basis of central bank independence, are quite stark and they’re more or less unchanging over time.

And so, it’s a real interesting way of thinking about central bank independence, to look at it sort of historically and how it actually emerged and then how it’s justified analytically. And while they draw on one another, and I think do reinforce one another, you know, it’s convenient for the Legislature to be able to say, well, it’s best practice economically to do it this way. They are quite different stories, the two.

[00:08:36] Kevin

Yeah. Just maybe a little bit more about the Fed Treasury Accord. I have to admit I’m kind of embarrassed about this. You know, I’ve heard about this my whole career and, and I think a lot of people have. And you sort of assume that is, as you say, some kind of formal document, but it’s literally just a kind of a memo, isn’t that right?

And, it’s a couple lines, it’s not law. So, you know, this notion that hey, Trump can’t fire Powell because the Fed’s independent or all those things, it’s really based on the flimsy, almost comically flimsy grounds in some ways.

[00:09:13] Leah

Yeah, exactly. I mean, the Fed Treasury Accord is kind of absurd as a document, as a sort of founding document of any sort of institutional arrangement. That being said, that the Fed does have legal independence, you know, layers of independence. And I talk about this some in the book that, you know, there are a variety of independent agencies in the US government and there’s a variety of sort of levels of independence. And the Fed has maybe the most degree of independence. Because it’s got all kinds of things including protection for the head of the agency like Powell. He can’t be fired without cause, etc.

But it’s kind of an extreme form of independence and comes from the fact that it’s completely self funding. So, it’s not subject to budgetary restrictions like many other agencies are.

But it is quite interesting, I mean, for those of your listeners that are interested in administrative law, which I’m sure there are many, there’s not a clear-cut definition in the scholarly literature of what an independent agency or a non-majoritarian institution actually is. So, there’s a kind of constellation of things that usually come with being independent. But it’s not a kind of clear-cut legal definition.

So, you’re right, it’s a murky space in general.

[00:10:34] Kevin

I guess I’ve always thought, and I think most people have all thought about, you know, independence of central banks, of the Fed in terms of, you know, being able to set monetary policy in a way that’s immune from the short term desires of politicians. But you point out that it can actually mean a lot more than that.

And in fact, you recount a number of instances where the Fed and other central banks actually use their independence to actively oppose or undermine policies of democratically elected governments, and not just in the realm of, you know, monetary policy directly.

I was wondering maybe you could give us a couple examples of that.

[00:11:18] Leah

Yeah, that can happen in a few ways.

So, I mean, it’s worth sort of stepping back and just saying that the mandate, and the way that the Fed interprets its independence, as you say, is to act in a particular way, towards particular aims, these mandated aims that you find in the Federal Reserve act, regardless of government policy.

So, you know, you can think pretty quickly of examples of ways in which those things would conflict. For instance, you know, if the government is trying to create more jobs and especially in certain regions, and at the same time, you have the Fed tightening policy in an effort to slow down the economy. There’s obviously going to be tension there, and you can imagine, conflict.

But more specifically, in some of the things that I detail in the book, are examples of things like the Fed Chair literally going to Congress and saying, we think the bills you’re trying to pass shouldn’t be passed. So, you have examples of that in the form of the Credit Control act, which I think is a particularly interesting one because it was an example when the Legislature, in the ‘70s, was trying to give the Fed more explicit powers to guide credit. And to sort of push credit in particular directions in the economy.

And the Chair of the Fed, at the time, came before Congress and said, you can’t do that, and you can’t do that and we don’t want that power because it would be political. So, the argument was, how are we supposed to know where to guide credit? You know, is it supposed to go into defense? Is it supposed to go into agriculture? Sort of what should we be doing? That’s your job, essentially saying to Congress, that’s a political decision. You should be doing it.

So, you get a lot of instances where there’s chafing between the two institutions. And that can happen in a way that is kind of more basic in a sense that the Legislature is trying to achieve something and monetary policy is making it more difficult. Perhaps a particularly explosive example of that is the UK recently.

I think, personally, the even more interesting examples of that tension come when it looks like the Legislature is essentially trying to abdicate responsibility for something. So, let’s have the Fed take care of it, because then we won’t have to make the, the tough decisions. Yeah.

[00:13:56] Kevin

So, you have the legislature saying, hey, we don’t want to make these tough decisions. And you have the Fed, on the other hand, saying, well, we don’t want them either.

[00:14:04] Leah

Yeah, exactly, exactly.

And I mean, in the book, too, I talk about this, I use the phrase, the buck stops nowhere in some situations because essentially you’ve got a really problematic institutional arrangement where, you know, Biden came out, for example, and said, don’t worry about inflation, guys, that’s the Fed’s remit, and they’ve got it under control. They’ll solve that.

But then you also have Powell testifying before Congress saying, this particular type of inflation is one that we can’t address the core problem. We can’t address the core causes. We can slow the economy down and sort of try and get aggregate demand and aggregate supply back in alignment. But that’s not the core problem here, the supposition being a sort of supply side issue.

And so you essentially have no one taking responsibility for addressing the core issue. And my argument in the book is that that this should be a political responsibility. This should be a responsibility of the elected officials, but they’re delegating it and abdicating responsibility. And central bankers are doing their best. They’re doing with what they’ve got, but really it’s quite limited and it’s not good for democracy.

[00:15:21] Kevin

Yeah. And it’s a subtle point in some ways, but I think an extremely important one. And the analogy I think you use in the book, at one stage, is like exercise muscles. If you don’t use them, they shrink and they become weak. And you basically have said that, well, that’s kind of what’s happened to the Legislature with regards to monetary policy, is that they actually constitutionally have control over money, but they’ve gradually ceded power to the central bank. And in doing so kind of have, I guess, lost their strength, lost their ability, lost their willingness to kind of act in these areas.

And so, it’s like, well, we’ll just delegate it to the Fed. And that gives us the ability to criticize if things go wrong, but not have to take any hard decisions.

[00:16:14] Leah

Exactly. In the book, I make a distinction between formal power and effective power. And so, of course, the Legislature retains the formal power over monetary policy today in that Congress could pass a law tomorrow that gets rid of the Federal Reserve. The Federal Reserve has no constitutional basis separate to the Legislature’s powers to constitute it. So, they have formal power.

However, their effective power has essentially waned over time as a result of delegating monetary policymaking powers to an independent central bank for so long without revisiting them. And the issue there, as you say, is that if the legislature doesn’t sort of, as I say, know and regularly show its power over monetary policy, then it’s ripe both for sort of usurpation, for that power to kind of find its way into someone else’s hands. In this case, I argue, the central banks. But also, for sort of ossification and erosion of the legislative sort of knowledge of the power and its capacity to do things differently.

And I argue that this is really foundationally problematic for democracy both in general, because the Legislature, as the legislating body of the democracy, should have sort of effective and active power over public policy in general, and, in a wide sense, but also specifically in the case of money, because, as I observe it in the sort of introduction to the book, part of the motivation of writing this book is to just point out that money and democracy are fundamentally intertwined.

You know, if democracy is a project of us collectively shaping our future. Determining what society is going to look like tomorrow, in 1 year, in 10 years, for the next generation, absolutely foundational to that project is determining what should be built, how we should be educated, where money should go, what the infrastructure should look like. And monetary policy is central to that.

And I just fundamentally believe that monetary policy is alongside the monopoly of violence in sort of defining capacities of the state, and that therefore, if we’re calling ourselves a democratic state, monetary powers need to be under democratic control.

[00:18:38] Kevin

And that’s an interesting comparison, because I guess one of the reasons people would give for having an independent central bank is that, hey, monetary policy is too complicated for elected politicians. But as you say, so is defense policy, so is energy policy. These are very complicated technical issues. Yet we accept that, you know, we have political control over them. So, what is it about?

[00:19:06] Leah

And not only just accept, we insist. We insist that it’s our elected officials that are in charge of those things because they’re so important. I use the phrase in the book, the project is not to reject expertise, it’s to figure out how to employ expertise without succumbing to rule by experts. And I think that’s really a tricky balance to strike over time. But what we need to be striving for.

[00:19:32] Kevin

You know, one thing I thought about was, you know, in thinking, well, what would it look like if Congress was in control of monetary policy? And I started thinking about tax policy. Because we still, you know, the Legislature obviously controls that. And in the US, it’s almost micromanaged. It’s so ultra complex, they want to favor one industry, so, we’ll have a tax incentive, a tax credit, that gets revised or repealed in the next administration.

So, it’s kind of interesting in the sense that on the one hand, Congress or the Legislature is like, well, monetary policy is too complicated for us, but tax policy is not. And we’re going to fiddle all the dials. But I guess a counterargument to what you are suggesting is, wouldn’t we end up with a monetary policy that looks like our current tax policy, ultra complex and not very effective if we handed it back over to Congress?

[00:20:33] Leah

Yeah, I suppose it’s an interesting question, the specific context that you’re offering of the complexity of tax policy. I mean, I suppose my first reaction is to say we have quite complex monetary policy as it goes today. I mean, that’s one of the arguments of keeping it independent, is how complex and technical it actually is. So, I’m not sure it would become more complex.

In terms of its effectiveness, I get this question a lot. So, if we’re going to put this essential power back in the hands of the Legislature, isn’t this going to create a monetary policy mess? Isn’t this the argument that technocrats and insulated central bankers will deliver better monetary policy? And it’s just not clear to me. That’s not clear to me on a few levels.

One is historically, yes, there are examples of times when monetary policy was more under the power of the Legislature in which we had inflations. But there’s similarly examples in which we didn’t, and examples in which we had inflations under independent central banks. So, the relative sort of historical comparison is not clear to me. It’s also not clear to me theoretically.

So, the argument, usually from the economics literature on a theoretical basis, is that politicians will be motivated by election, and so they will inevitably sort of juice the economy right before the election and that will lead to long standing inflation. And that’s as a result of them being suffering from what they call in the literature, right time inconsistency.

But there are two things about that I think. One is kind of what we’ve already been talking about, which is that you can describe time inconsistency problems for all kinds of forms of policy; environmental policy, tax policy, defense policy. There are lots of policies that what looks to be in the short run like the best idea is not the right idea in the long run. And yet we don’t insist that those things are insulated either because we believe that citizens aren’t dumb. And politicians can say, look, this might look good right now, but in the long run, for the next generation, we need to do things differently. And sometimes they get it right and sometimes they don’t. But those are just kind of the breaks. That’s politics, sort of.

So that’s the second thing. And then the third thing is that, as you have pointed out, it’s a relative choice. It’s not let’s decide between democratic politics and ideal policy, whatever that might be, however you might define that. It’s let’s decide between democratic politics and insulated central bankers.

And I think, first of all, part of the argument of the book is that if you’re making that decision, you should set the bar for delegating monetary policy powers to independent central bankers really high because it’s a threat to democracy to sort of put that outside of the Legislature.

And then after you make that point, it just seems quite clear to me that they don’t meet that bar because even insulated central bankers suffer from the time inconsistency problem, as they’ll very well point out. Forward guidance builds that problem. It makes that problem front and center, promising to do something right now and then coming to the point in time in which you’ve promised to keep rates low, but all of a sudden the best thing to do is to raise rates. That’s a time inconsistency problem.

You know, bailing out corporate debt markets when they really need it, which is what the Fed has done in multiple times recently, creates an incentive for corporate debt to proliferate. They’ve done that multiple times. That’s a time inconsistency problem.

So, it just doesn’t seem obvious to me in the way that people tend to see it, that policy would be so much worse if it were democratically guided. And you know, as you know, in the book, this isn’t about eliminating the central bank. This isn’t about getting rid of monetary policy experts. It’s not about sort of, you know, as I say, sort of folding the whole Fed into the treasury or getting rid of it.

It’s simply about exercising regular power of democratically elected officials to steer policy, to have an opinion about policy and in particular credit policy. And so, yeah, I just think the damage that would be done by that, so to speak, is not clear to me that it would be damage. And it’s also clear to me that it would be hugely powerful as a political tool.

[00:25:19] Kevin

So, let’s, let’s talk about that. Let’s talk about your view of, you know, kind of a better way to manage the central bank. And at the heart of what you’re suggesting is this idea of what you call iterative governance.

And you describe it as the, you know, as you say, you’re not talking about eliminating the central bank, but you’re talking about governing it in kind of a different way. And you say it’s important for the Legislature to regularly show and know its power.

So just can you tell us, you know, explain what you mean by iterative government in particular, this notion of showing and knowing power?

[00:25:58] Leah

Yeah, definitely.

So, it comes from this observation that we were talking about before that in general, but in the legislature specifically, if you give up your power to do something for an extended period of time, two things are likely to happen. One is that your powers are likely to wane. This is this idea that if you don’t exercise it, right, the muscles are going to atrophy. And also, that that power is likely to find its way into someone else’s hands.

So, the common example to defend central bank independence, right, the analogy is usually Ulysses tying himself to the mast, right, to avoid running into the sirens. And essentially what I say is, in the book I point out quite a few important, I think, disanalogies between central bank independence and Ulysses.

But assuming you accept that analogy, well, if Ulysses is tied to the mast indefinitely, he’s going to lose his powers, both physical and sort of power over the crew and the crew itself, maybe the first mate in particular is likely to gain power. And so that’s the kind of diagnosis. And so, the solution, I argue, is essentially for the Legislature to know and regularly show its power.

And what that involves is just being regularly involved, understanding what decisions are being made and why they’re being made, understanding what alternatives there are out there, and actively displaying either assent to the decisions of the administrative body, in this case the central bank, or telling it to do something differently. And I developed this using, I mean, we don’t have to go into this in detail unless you want, but I developed this with some political theory. In particular, drawing on Rousseau and his ideas of how sovereigns could stave off usurpation and ossification. And he talks about the sort of regular exercise of power and revisiting core questions of how things should be arranged.

[00:28:03] Kevin

Don’t we have that in the U.S. already? I mean, the Fed, there’s a Humphrey Hawkins testimony and you know, the TED has to come and speak before Congress. Don’t we have that already?

[00:28:14] Leah

Really good question. So, I talk about this in the book. Essentially, the Humphrey Hawkins testimony that does happen regularly is fundamentally about accountability. So, you’ll see this if you watch it, where you get the Legislators asking the Fed Chair sort of why did you do this? Why haven’t you done that? Could you think about doing the other thing?

And inevitably, multiple times throughout the testimony the Chair will say, well, our mandate is price stability and maximum sustainable employment. And so, here’s why what we did fit that mandate, or here’s why we haven’t done what you’re suggesting based on that mandate.

And so, what I describe in the book is that essentially that’s a kind of guardrails and compliance approach. So, the Legislature has set up these guardrails and the terms of the mandate, and then Humphrey Hawkins testimony is there to ensure that the Fed is staying within their guardrails. And that’s important, that’s very important holding an agency to account.

But I distinguish that, in the book, the very important difference between holding someone to account, and steering their actions going forward, having the power to guide them going forward. Accountability is fundamentally backward looking. If someone’s taken to court, it’s about what they’ve already done, and then we hold them to account to what they’ve already done, but you have the power to steer someone’s actions in a forward looking way. And that’s fundamentally different, and that’s what I’m advocating here.

So, I want to create mechanisms for the Legislature to say to the Fed, we want you to do this differently, we want this to work differently, we want monetary policy to be made differently, etc. going forward. And so, that’s really the fundamental difference and why I think something like the Fed Chair’s testimony isn’t sufficient for achieving what I’m trying to achieve.

[00:30:13] Kevin

And of course, you know, I grew up with Alan Greenspan as Chair, who literally took pleasure in avoiding any kind of answer and everyone knew it.

[00:30:26] Leah

Understand me, I’m not saying it right. It’s not…

[00:30:30] Kevin

Yeah, yeah, yeah. And of course that didn’t end very well.

So, what you would like to see, without getting into the super gory details, is you’d like to see a kind of a regular appropriations process. And you know, basically that’s what happens over any other government agencies, Congress has the ability to say, okay, well this is your budget. This is how much money you’re getting with the Fed. Obviously they don’t need that, they can just create the money to support its own operations. So, you’d like to see that happen.

You have this, what you call preferred asset taxonomy, which is, I think, kind of a basically saying, hey, here’s some, you know, different types of areas where we could allocate credit in the economy and we’re going to give it a score. One, let’s say being the, most preferred and, you know, five, being the least preferred. (You don’t say that in the book. I’m making those numbers up.) But basically, some type of, here’s where credit could go and here’s basically our preference of where it should go.

And you say that could be very specific or it could be very general. So, you’re not advocating for a particular type of credit control. You’re advocating for a structure where Congress says, this is where our preferences are. And then coming back, whether it’s every year, every six months, whatever, and saying, okay, here’s what we observe where credit went. Why is it different from what we’re suggesting?

Is that kind of broadly correctly framing of what you’re suggesting?

[00:32:08] Leah

Yeah, yeah, yeah, yeah. It is.

So, I mean, the way that I describe it to my students is that I think about the monetary system as like a set of pipes around the country. And it’s kind of a public/private hybrid system, but it’s all regulated by the state.

And essentially, I’m advocating sort of for two ways for the Legislature to guide the delivery of water through that pipe system. So, one is about how the flow looks. Is there enough flow to particular regions? Is there enough flow to particular sectors of the economy? We would like to see it going in different areas. We’d like to see different amounts and different speeds, etc.

And that’s what you’re describing here with this kind of, as I call it, credit guidance, annual credit guidance through something like, potentially, a preferred asset taxonomy, which is, as you say, a structure for the Legislature to comment on credit allocation.

Because as I see it, and as I argue for it in the book, you know, constitutionally, the capacity to coin and regulate the value of money belongs to the Legislature. And so, the Legislature has delegated that to the private financial industry, more or less, to allocate credit across the economy.

And essentially what I’m trying to create here is a regulatory mechanism through which the Legislature can say, okay, we, we want to add some conditions. We want more here, we want less there, we don’t like how you’re doing it this way, and get involved in that allocation procedure, in steering it (I think steering is really the best word) to the degree that they want to steer it. As you say, that could be very specific or it could be quite general.

[00:34:00] Kevin

I can just hear a lot of our listeners are investors, traders. That’s my former profession as well. And so, I can hear a lot of people saying, well, hold on, we really, that’s what we really don’t want. We don’t want the government saying where money should go. We want the market to dictate that to, you know, let’s just create the pipes and then let the flow come naturally.

That’s the, the market mechanism for allocating credit. How would you, I mean, you must hear those concerns all the time. How would you address that as, I don’t know, kind of creeping socialism or something like that?

[00:34:39] Leah

Yeah, I guess what I would say is that that argument, as you say, sort of like what we want, the want there usually is based on efficiency. So, it’s the argument that the market is the most efficient allocator of resources. And it goes back to very interesting, but some quite antiquated arguments about local bankers have better knowledge of the investments in their region, and so we should be allowing them to make those decisions rather than the central government. Which, of course, that’s not really the way that the financial system works today. It’s a lot more complicated, and a lot more automated, and a lot more centralized than that.

But anyway, just to get beyond that. So, the central value in that argument, generally, is efficiency. And I think there are two things to say about that. One is it’s not always maximally efficient, as we’ve seen in recent times, in my view, with the difference between sort of investments going to the real economy versus the financial economy and speculative assets. But more importantly and perhaps more convincingly to some of your listeners, is that efficiency isn’t always the top value, especially to society.

And so sometimes I think it’s legitimate for the state to say, look, regardless of what you think is going to be most profitable, we think that we need to have more investment in these particular regions because of regional inequality, or we need to have more investment in these particular technologies because of our interest in addressing the climate crisis or a variety of other concerns.

And essentially what I’m saying is that leaving the preferred asset taxonomy as potentially general, as I have, is an opportunity for the legislature to say, okay, we just like what’s happening. We think it’s very efficient. We’re pleased with it. We think it’s doing the best we could possibly be doing.

So, there’s a possibility that we could institute this form of credit guidance tomorrow and then nothing would change. Because the legislature would essentially say, we’re very happy with everything that’s happening right now.

But the point is that there would be the opportunity for the state to say, it is totally within our rights, it’s within our powers, it’s when that within our constitutional prerogative to guide credit in a different way. And we have democratic mandate to do that. And this mechanism is meant to make that power palpable for when they do want to use it.

[00:37:16] Kevin

And that gives them a framework for after an episode like 2008 or 2020 in particular, where there was effective credit guidance through the Federal Reserve’s various special purpose vehicles to come back and say, well, hold on, this is what actually happened that wasn’t consistent with what we wanted, so we’re not going to have that happen again.

The other thing I thought about, as you were talking, which I think might resonate with our audience, as well, is there’s a lot of concern about the, you know, financial repression. The need to finance the deficit, over time, is going to mean that there’s going to be changes in rules that essentially not only force different sort of institutions to buy government debt, that force the Fed to buy government debt. And that’s a real fear amongst people, you know, investors out there.

But actually, with your (I’m thinking, kind of on the fly here), structure, that would be a way for that to be brought into the open. In other words, it’s like, well, okay, you know, looks like most credit went to us and, you know, someone’s got to explain that. Whereas right now if financial repression would kind of happen it’s more behind closed doors. So, it’s potentially… I mean, do you read that? Is it a way to shine a light on that?

[00:38:53] Leah

Totally, a huge part of the project here is to observe that monetary policy always, including since the 1970s or whatever, is political. It’s massively political. Where we invest, where credit goes is, as I said at the very beginning, hugely determinative of the world that we create. And that is, in my view, fundamentally sort of the stuff of politics is our sort of collective design of the future society that we live in. And part of the project here is not to say necessarily that the way we’ve been doing it is better, or worse, or wrong, or right. It’s that it should be part of the political discussion.

We should be having an explicit conversation about how we want to allocate credit, who should be in charge of that, on what basis should it be done, et cetera. And so, you know, that applies to conversations like financial repression. It also applies, as you said, to the Fed’s, you know, bailout packages and their response to 2008 and then again in 2020 and all these facilities that they opened.

That’s quite an uncomfortable position for the Fed to be in, given its ostensible independence and its desire not to be picking winners and losers and things. And so, if you had a system like the one I’ve offered here, that’s just going to be political from the get go, it’s going to be a decision from the get go that comes from the political body. And I think that that’s just the way that it needs to be. That should be part of the discussion about how we’re going to do things. There should be no pretense of neutrality, really, because that’s a false picture in my view.

[00:40:42] Kevin

So, there’s another element to your suggestion which is very important. And if you’re worried about regular control of the Legislature over credit, then strap yourself in because what you’re saying is we should also have a regular rechartering discussion.

We should regularly whether, and again, you don’t say it should be every couple of years, 10 years or 20, but you just say periodically the Legislature ought to consider whether to recharter the Fed itself. Why do you think that’s so important? And then how would you imagine it working?

[00:41:20] Leah

Yeah. So back to the pipes analogy. So, if the credit guidance portion of iterative governance is figuring out the sort of flow of water through the pipes, then the rechartering discussion is thinking about what the pipe system is itself. So, are there certain regions that aren’t reached by the pipes? Are there pipes that are decaying, that need to be sort of reinvented, should we get rid of some of them, et cetera? It’s the institutional reconsideration.

And the point of this is that I think that the Legislature needs to be regularly thinking about not just specific sort of credit policy and monetary policy decisions in terms of where credit’s going in the economy, and the basis on which sort of the Fed is making its choices vis a vis, sort of collateral policy, et cetera, but also the institutional setup. So, discussions of things like the reach of regulation, how we regulate, you know, non-bank financial institutions, the euro/dollar market, the mandate of the Fed, should we be pursuing 2%, should it be 4%, should it be defined negatively – price stability as the absence of a particular degree of volatility? What’s the point of the Federal Reserve regional bank?

Should it be doing what it’s doing currently or should it be designed completely differently as a more public form of that institution? Should we have a public option for accounts at the Federal Reserve? Should we have a digital currency, etc. All these types of decisions that are, you know, constantly coming up and there are always, you know, proposals for reform and doing it differently. Those are things that Congress should be considering.

And one way of getting to that point, I think, is to think about (many of your listeners probably know about this) that the Fed has now committed to itself doing a review every five years of sort of how we’re making policy, the basis on which we’re making policy. And that review essentially has three legs. So, they ask academics for their point of view and scholars. They do the Fed Listens project, which travels around the country and talks to sort of people and local business owners and things. And then they have a sort of internal staff review.

But it seems to me, while the impetus for that is great, a regular review, reassessment of how we’re doing things, the key missing element is the Legislature. The one body that could tell the Fed to do something differently, even if it didn’t want to. And the one body that is actually made of democratic representatives is not part of that picture. And to me, they should be the ones driving something like that.

[00:44:18] Kevin

I always have to slip a tennis analogy in here, but it’s just kind of like, you know, you’re getting different people saying, well, you could improve your backhand if you did this and this. But really what you need is someone saying, actually you should give up on tennis because you’ve maxed out.

When you talk about the regular rechartering in terms of, you know, deciding what the pipes are, what popped into my mind was the Fed’s swap lines. I mean, they’ve been there for many years, but they really emerged in importance in 2008, and then again in 2020.

And, you know, if you really think through what’s happening there, it’s essentially the Fed being the lender of last resort for, if not the global banking system, certainly the Western banking system. And you know, swap lines are basically when the Fed provides a loan to foreign central banks and then those foreign central banks can then, in turn, loan those dollars to their own institutions that need them. So, it’s basically a way of the Fed loaning dollars to banks that are outside the US. And that just kind of happened, and it wasn’t voted on. And I think very few people actually appreciated what was going on, certainly in the general populace.

And that seems to be something that would be, you know, that should be part of a regular reconsideration. And the Fed won’t do that itself because it’s just going to say, well, how can we do our job, our current job better? And what you’re saying is, hey, you know, that may not be a job we want you to do at all.

[00:46:02] Leah

Yeah, exactly, exactly. I mean, the swap lines are unbelievably massive pieces of the public infrastructure. We’re sending dollars all over the world. We’re sustaining a global economy, really, and a global financial economy through the Fed acting as a kind of de facto, as you say, lender of last resort central bank to the world, and in particular to the dollarized world, the euro/dollar market, the world that relies on dollars.

And that, in and of itself, is one of these choices that you’ve set, that you’ve sort of pointed out could be much more in the light, could be much more political and have a discussion around that. And, it’s fascinating to me.

So, there’s a pretty developed literature in economics, but really political economy, about the sort of power of the US in the international financial market, particularly post 2008. And there’s a strong strain in that literature that essentially argues that US power has been sort of greatly reduced, actually.

And their evidence for that is saying that, well, the US had to offer all these swap lines to these other countries, and it had to do all sorts of bailouts to international financial agencies. Why would it do that if it didn’t have to? Why, if its power was so great, and it was a domestic institution, wouldn’t it just let these international financial bodies sort of fall apart? Why would it support foreign financial institutions in this way?

But the answer to me is quite clear. I mean there’s sort of two answers to it, right? One is that it has huge power, I mean, huge bailout power that it used internationally in addition to the swap lines post 2008. But it did that because the Fed’s remit, and it did the best of its ability to fulfill its remit, is to sustain the stability. I mean, it was founded in 1913 to sustain the stability of the private financial system domestically. But the American private domestic financial system is hugely intertwined with the international financial system. So, what it’s doing is sustaining the basis of the domestic financial system, which has roots all over the world.

But what it isn’t, and I think this is what that literature is getting at, but kind of missing the mark a little bit, is it’s not democratically domestically rooted. So, it’s not serving the interests of the American populace sort of as articulated by a democratic Legislature. Like that’s for sure. But that’s not what it’s sort of been doing for over a hundred years now.

So, the point of this system is to essentially try and realign those things a little bit. And that might have quite severe consequences for sort of our relationship to international financial system, for sure. But part of what I’m trying to bring out in the book is that those things are misaligned. And so, if we need to kind of make a brave statement about what we think about that rather than continuing down this road of pretending that the contemporary monetary arrangement in the US is democratic in a meaningful sense.

[00:49:23] Kevin

Yeah, I kind of think of that as trickle down insurance. Like the idea is, well, we’re doing this because if we didn’t support the international financial system, then there would be a crash in the economy and you’ll all lose your jobs. Which may actually be correct. But the point is, if you’re justifying that based on, hey, we don’t want you to lose your jobs, then why not insure that directly, you know, instead of having the insurance trickle down from the support of international financial system.

[00:49:57] Leah

Because, the political commitment would then be, oh well, we’re just never letting the private financial system fail. And no one would say that politically. So, I’m on board with you with that one. So that’s the problem. And that’s what I’m trying to force someone to say, essentially, is either you need to say that, or you need to change the system to make it more democratic.

[00:50:20] Kevin

The last few lines in one of your chapters really stuck out to me and I’ve been thinking about it a lot. And you say, from a democratic perspective, uncertainty about the future is not a factor of the world we must cope with, it’s a requirement. To sustain a healthy democracy over time, the future must be uncertain. What exactly do you mean by that?

[0:50:48] Leah

Yeah, it’s a great question.

I’m glad you brought that up because sort of temporality and uncertainty are the core pieces of this book that I’m bringing into my future work that I’m working on a lot more. So, it’s something I’ve been thinking about a lot.

And pretty much what I mean by that is this. If we think of democracy as a system of government that aims to ensure that the people are the authors of the rules that they live by, so, they’re sort of collectively autonomous and they are rule – government for the people, by the people, of the people, then what that means is you cannot commit credibly, over long periods of time, to ensuring that policy will serve the interests of one particular group or another. Because the point is, is that if we, if the people are ruling, and over time we have elections and we change who’s in charge. And as Aristotle put it, we rule and then we’re ruled in turn, then you have to allow for the possibility that things are going to change in the future. And so, the future has to be uncertain because no one is in charge in a democratic system indefinitely. And so, you can’t put in place policy that will serve the interests of one particular group indefinitely.

And so, the idea there is that democracy can be uncomfortable and can be risky because you have to put your faith in the system that’s going to empower some group of your fellow citizens over time, but you never know which one. And that can be risky, but that’s the name of the game essentially.

[00:52:40] Kevin

And I think what really struck me is you’re saying, okay, yeah, if you introduced my framework, then that will introduce more uncertainty in monetary policy because the Legislature could change, you know, they could change where they want credit to be allocated. They could decide to recharter the Fed in a different way. And I kind of thought about that. Initially I was like, eh, that doesn’t sound great. And then, as I kind of thought more about it, obviously I look at things through a more narrow financial lens. And you know, we wrote this book about carry. Carry trades kind of proliferating around the world. Carry trades are short volatility. So, they proliferate in a world that’s very stable, and then they crash, and that requires intervention, which consolidates power with the central bank.

So, I started thinking, well, maybe you could think of it as like stabilizing uncertainty, where you introduce enough uncertainty that it becomes too risky to take large leveraged positions that ultimately lead to fragility and bailouts. And I don’t know what you think of that.

[00:53:57] Leah

Exactly. So, I wrote a piece not long ago for the blog Phenomenal World, which is great if your listeners haven’t seen it. It’s a really fantastic sort of political economy website. But the whole piece was about distinguishing between two forms of stability. So, there’s the idea of stability as preservation, which is what I see the contemporary approach to central banking as pursuing, which is trying to maintain more or less the status quo structurally and prevent massive booms and busts. And then there’s stability as resilience, and that is enabling change and sort of allowing it to happen in predictable and manageable ways.

And that’s kind of what I’m trying to talk about here. And the analogy I use in that piece is representative democracy. Because we know, every four years there’s going to be an election in the US. We know there’s a likelihood of change, but we believe that even as the rulers cycle through, the structure of our democracy is going to sustain and the way that we make laws will more or less be the same even if those laws themselves are changing. And so, what I’m trying to essentially do in the book is allow for a little bit more of that with monetary policy and credit policy.

So, we may be doing things differently in terms of how we guide credit, where it’s going, but there will be a sort of structure through which that happens, which makes it manageable. But I think you’re pointing to the exactly the right thing. I mean, quite a few people have said, well, if there’s recharting of the Fed, or if there’s credit policy, we’ll have no idea what’s coming.

But part of the point is like, yeah, investors and traders will have to take politics a little bit more seriously, like genuine democratic politics a little bit more seriously because it might have more consequential impact on their world. And I think that’s no bad thing if we think we’re in a democratic society. And I also think (I point this out in the conclusion), I think that’s no bad thing, sort of from the perspective of democracy. But I also think that’s no bad thing for democracy.

I think there’s a good chance, and I maybe this makes me sound too naive, that empowering the Legislature – actually making its decisions more consequential in a serious way. Like, what you’re going to decide will have a huge impact on the financial world, for instance, might hopefully bring a bit more decorum and maybe more genuine responsibility and sort of a form of politics that takes itself seriously back to the Legislature and a little bit less sort of bravado and performance. If what you say really has intense consequences, then you might be a little bit more careful about what you say.

[00:56:55] Kevin

Well, thanks for that. And I think that’s a good place to kind of wrap up.

I mean, I remember when I, you know, again, I’m from a different generation, but when I was, you know, kind of thinking about what to study, the notion of political economy seemed really dull and formal and academic. But I think what’s happened now is that everyone’s understanding again that you can’t separate the two.

And we’re going to be wrestling with these questions, now, a lot in the next, you know, in the coming years and decades. And I appreciate you taking the time and writing the book and joining us on the show today to explain some of your ideas.

[00:57:42] Leah

Yeah, thanks very much for having me. It’s been a great conversation.

[00:57:47] Kevin

Okay. Well, Leah’s book is called Our Money: Monetary Policy as if Democracy Mattered. It challenges conventional thinking, gives you a new perspective on how central banks could and should be governed to best serve all of us as citizens. So, as I said, I think this is just the beginning of these discussions. And, you know, check out the book if you want to kind of get an early, I think, preview of the sort of conversations that are that we’re going to be having more and more of.

Make sure that you follow Leah’s work because you can tell from our conversation that a lot of these ideas are not discussed enough on mainstream media. So, for all of us here at Top Traders Unplugged, thanks for listening and we’ll see you soon.

[00:58:34] Ending

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