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Treasury Secretary-nominee Janet Yellen has been all over the news lately. It seems Yellen has been earning millions of dollars in speaking fees from Wall Street financial firms that she will soon be in charge of regulating. Progressives are worried this cushy prior relationship will cause Yellen to be soft on big banks. Given Yellen’s public-policy track record of favoring tighter regulations, this seems unlikely.
However, there is a more worrisome prior relationship no one is talking about. We are referring, of course, to the fact that Yellen used to be chairperson of the Federal Reserve. Yellen’s pending appointment raises new questions about the Fed’s independence from Congress and the Treasury.
Few Americans are old enough to remember the last time the Fed and the Treasury got too cozy, but the results weren’t pretty. During WWII, the Fed embarked on a policy of pegging the interest rates of government bonds at very low levels. Essentially, the Fed created new money at the request of the Treasury and lent it to the federal government by buying Treasury bonds. This monetization of government debt made it possible for the government to finance the war effort without having to further raise taxes, but it spurred inflation. The Fed lost its independence and became the handmaiden of the Treasury.
It wasn’t until 1951, with inflation reaching 21% on an annualized basis, and after a year of feuding with the Treasury, that the Fed won back its independence in an agreement known as the Treasury-Fed Accord.
Today, the Fed’s credit- and balance-sheet operations are increasingly reminiscent of the naughty behavior the Fed engaged in before the Treasury-Fed Accord. First, the Fed has purchased trillions of dollars’ worth of Treasury debt since 2008. Given that most of this debt is unlikely to ever be sold off, this is tantamount to debt monetization. Then, last year, the Fed announced it would begin pegging interest rates on Treasury bonds, keeping rates near zero through 2023.
The appointment of a former Fed chairperson as Treasury secretary further blurs the distinction between the Treasury’s fiscal-policy objectives and the Fed’s monetary policy.
Government spending should be financed through taxes or deficits, which are subject to the political process, not through monetization of debt.
We hope Yellen’s appointment is merely bad optics and not a portent of the Federal Reserve’s becoming an arm of the Treasury.•
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Bohanon and Curott are professors of economics at Ball State University. Send comments to ibjedit@ibj.com.
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