The Forgotten Secrets of the Hidden Temple

The other prevailing presumption is that the political class cares deeply about investor opinion on the matter. This belief rests, for one, on the uncomfortable feature that monetary policymaking is partly a self-fulfilling confidence game. The sense that the leader of the Fed clings to its longer-run mandate of price stability keeps inflation expectations in check, thereby limiting the volatility of asset prices making it easier to deliver such an outcome. For another comes a particular reading of history. 

The foundation story in the modern era of Fed policy, when government support for the central bank’s commitment to price stability stabilized inflation, begins at the start of that era. In autumn 1979, inflation was running close to 10 percent and on an upward trajectory. President Carter, appreciating inflation was ultimately a monetary phenomenon, recognized that then-chair G. William Miller was inadequate to the task. Miller was expeditiously and gracefully moved sideways from the job to become Secretary of the Treasury. This made way for the overwhelming favorite of the capital class, Paul A. Volcker, then-president of the Federal Reserve Bank of New York. The Administration appreciated that working with financial markets would avoid the turbulence that would otherwise derail its fiscal plans, and history was made.

Over time, this commanding precedent of not rocking the market boat hardened into an external constraint on Fed choices, explaining why chairs Volcker, Greenspan, and Bernanke were subsequently reappointed by presidents of different political parties than had originally appointed them. This also explains the widespread sense that President Biden will follow the script and reappoint the Fed incumbent.

Like many foundation stories, this one is mostly myth. Everyone, especially those having an association with the Fed, wants to believe that politicians understand that inflation is a monetary phenomenon, that the chair should be accountable for results, and that the confidence of investors should be nurtured. In fact, the events of 1979 provide nothing to support these pillars of faith.

The best source for a more appropriate understanding is William Greider’s Secrets of the Temple, a media sensation in the late 1980s that remains the most important description of the place of monetary policy in the political economy. Published in 1987 but first told in installments of The New Yorker, Greider’s tome, despite its clumsy progressive-tilted economics, correctly identified the societal strains on policymaking. What we know now was there then. Inflation is a regressive tax that especially burdens the poor who consume disproportionately more of the goods going up faster in price. The incidence of the Fed’ policy actions is uneven, as it works through asset prices that benefit higher-income wealth holders. And monetary policy decisions shape the trajectory of the interest cost of fiscal policies.

The forgotten part is more important for current circumstances and owes to its exhaustive reporting of the decision process. The Carter Administration was rightly panicked by the public’s dissatisfaction with rising inflation, but it looked to administrative levers of control involving regulatory policies, especially involving the energy sector. President Carter viewed it as a crisis of beliefs and retreated for eleven days to Camp David. The result was his famous “malaise” speech identifying the problem as the immorality of rampant consumerism, and he sought the resignation of his entire Cabinet two days later. At the top of the chopping block was the Secretaries of Energy and Treasury. The latter job proved difficult to fill, with the first three candidates offered refusing it. The White House settled on G. William Miller because he was viewed as a reliable “team player.” This inconveniently opened the top slot at the Fed. After the first pick said no, the job fell to the market-candidate-in-waiting Paul Volcker. Even then, Volcker was viewed warily and not too much significance was placed on the decision.

Greider provides no support to the modern Fed foundation myth. The Carter Administration was searching for an administrative solution to inflation. G. William Miller was rewarded with a promotion, not hauled from the helm. Paul Volcker’s appointment was more happenstance than market decree. 

This matters because the Biden Administration similarly appears to be looking for a regulatory solution to a monetary problem. Moreover, this is the first Democratic team in thirty years excluding anyone from the Rubin-Summer-Geithner axis that had always been geared toward working with financial markets. Who remains to listen to messages from financial markets? Still, market participants believe the myth, making them confident that Jerome Powell will be rewarded with a second term. The reality is that they should prepare more for an outcome apostate to that faith.