That time the Fed bowed to political pressure before an election

Hosted by Kai Ryssdal

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The U.S. central bank largely operates independently from the realm of partisan politicians. Yes, presidents nominate Federal Reserve officials that the Senate then confirms. But policymaking is usually left to those experts based on economic fundamentals — not political currents.

There are, however, moments in Fed history where politicians intervened to try to tilt the economy in their favor. This is something worth revisiting in an election year. Especially one where Federal Reserve independence has been a talking point, after Republican presidential nominee Donald Trump said he believes the president should have some influence in the actions of the Fed. For her part, Democratic nominee Kamala Harris supports Fed independence.

To understand what infringement upon Fed independence looks like, you can wind the clock back to 1971. Richard Nixon is president, and it's the lead-up to his reelection in 1972. But before that happens, he hatches a plan to sway then-Federal Reserve Chair Arthur Burns — and the direction of the U.S. economy.

Sebastian Mallaby, senior fellow at the Council on Foreign Relations, has written about central bank independence and when it's been encroached upon in his 2016 book "The Man Who Knew" (which is primarily about a different Fed Chair, Alan Greenspan). Mallaby spoke with "Marketplace Morning Report" host David Brancaccio to discuss. The following is an edited transcript of their conversation.

David Brancaccio: This topic, Federal Reserve independence, has a habit of rearing its head during election years. I mean, the Fed influences where our economy is headed — at least they try. And all that has a role in how voters make their decisions at the polls. But, in theory, the central bank in this country is supposed to be independent.

Sebastian Mallaby: Yes. I mean, that independence is more a convention than a law, and it depends on the president choosing to respect the convention.

Brancaccio: Yeah. And to be absolutely clear — before we proceed further — the Federal Reserve and its current chair, Jay Powell, have said this year's election has no bearing on the decisions his team makes. But take us back to the early 1970s: Richard Nixon's working to get elected again. What was happening in the U.S. economy in '71, '72?

Mallaby: You saw the beginnings of what became known as "stagflation," where you had both stagnation and inflation all at once. It was a tough moment, not something to which leaders in the U.S. were accustomed because of the prosperity of the preceding couple of decades.

Brancaccio: The Fed chair at the time was a man named Arthur Burns. And what did the Nixon people set out to do in '71?

Mallaby: They came up with this idea that they would pressurize the Fed Chairman Arthur Burns by leaking a story to the media to the effect that whilst Burns was proposing wage and price controls for everybody else in the economy, for his own wages he was demanding a 50% salary increase — and therefore was hypocritical, unpatriotic and despicable. And so this is an entirely made-up story, but they planted it in the press.

Brancaccio: And just to give you a taste of this, this is another moment where President Nixon is speaking with Office of Management and Budget Director George Shultz, who many will remember as Secretary of State later in the career, about what they've told the Fed Chair Arthur Burns about what to do with monetary policy. Now, the first voice you'll hear is unmistakably Nixon's:

Richard Nixon: You feel, as far as Arthur and the money supply, we got that about as far as we can turn it right now, have we? I mean, as far as my influence on him. That's what I'm really asking.

George Shultz: Yeah. Well, you know, he said he — that they voted to increase it.

Brancaccio: Does this pressure, Sebastian Mallaby, does it work? He's apparently come into line. Does he come into line?

Mallaby: He does. The White House arranged for one of Arthur Burns' Ph.D. students, who was close to him, to go deliver the message that "If you don't like this smear about you allegedly demanding a 50% pay rise, you know what you've got to do, Mr. Chairman." And what you've got to do, of course, is lower interest rates and talk up the economy.

Brancaccio: I get that the international consensus is that decisions on things like interest rates should not be influenced by politics. But there is a discussion that could be had about central bank independence. It's not all that democratic. I mean, we don't elect them.

Mallaby: Yeah, and I think the high point of central bank independence blew up with the financial crisis of 2008, because the experts did get it wrong. And I think that's opened the door, since then, to political populism, to attacks on institutions, to a decline of respect for expert judgment. And in that environment — which we are still in — I think there is more danger to Fed independence than there was in the heyday, when people took it for granted.