To say the old dictum that central banks in developed economies are independent ignores history and modern politics. The central bank, and with a focus on the Federal Reserve, has always printed money at a rate dependent upon the fiscal exigencies put upon the US government during crises or during stable periods.
First note that the Fed “prints” money when the Fed buys US Treasury debt, whether directly from the Treasury or indirectly from private banks and special Treasury dealers who have bought the Treasury debt in primary or secondary markets. The Fed effectively buys all the Treasury debt in the secondary market from bankers, but they are just the middlemen.
The Bank of England in 2020 allowed the Bank to directly buy UK Treasury debt: so here the link of “printing” money to finance deficits is more direct.
An amazing graph exists that Milton Friedman did not have since FRED the Federal Reserve Bank of St. Louis database was not yet around. Graph the Treasury debt held by the Fed and the currency in circulation. They match one-for-one almost exactly from 1959 to 2008 when Fed policy was almost completely “normal”. Reserves held at the Fed fell from 5% of deposits in 1970 to 1% in 2008. Reserves per-2008 are the only difference between currency in circulation and Fed-held Treasury debt. So the fact that Fed holdings of Treasury debt and currency in circulation marched along together shows how the Fed really does “print” money by buying Treasury debt. Of this the data leaves no doubt.
Also of little doubt is that the Treasury borrows heavily when crises hit the economy, be it the Vietnam War financed by Treasury borrowing, the banking crisis of 2008, or the Covid pandemic. Equally clear is that the Fed buys a large fraction of this increased Treasury debt during crises. Surprisingly perhaps this fraction of Treasury debt that it buys typically rises during these crises when the Treasury debt as a percent of GDP is rising. This means that the Fed printing of money as normalized by GDP rises by even more than the Treasury borrowing as a percent of GDP. This is consistent with findings in the academic literature such as by Eric Leeper as to how during high deficit periods, the Fed prints more money and increases the inflation tax as it is deemed rather than raising other statutory income taxes.
The fiscal theory of the price, with a new book by that name by John Cochrane, in short says that the amount of Treasury debt influences by how much the Fed prints money by buying more Treasury debt. This is self-evident when examining any historic crisis period. The Fed typically buys at least the same share of the rising Treasury debt during crisis, and the Fed even buys a higher share than normal of the higher-than-normal Treasury debt.
Central bank independence has NEVER existed in the United States. The Fed was established in 1914 and quickly allowed gold reserves to shoot up beyond what was deemed appropriate for a stable inflation rate. The money supply under this gold standard period then shot up and WWI inflation was substantial. Michal Bordo marks 1914 as the end of the classic gold standard period that had been in effect since 1834, with the US bimetallic standard going back to 1792. During WWI, other countries’ gold flowed into the US and caused US inflation.
The Fed had been established after the 1906 banking panic ensued and the Aldrich Commission was tasked with creating a central bank that could stop such panics and therefore provide insurance against bank panics. Nothing in the Fed’s 1913 statute allowed such banking policy and the Fed today still has no such banking insurance policy in its statutes (The 1946 Full Employment Act as fully amended by the 1978 Balanced Growth and Full Employment Act).
Federal Reserve independence has no real statutory basis and does not exist in any meaningful way. The only mandate of the Fed is a zero percent inflation rate target by the 1978 Act. The Fed ignores this. During the gold standard of Bretton Woods, post-1946, the Fed also ignored the strictures of that mandate.
During the Vietnam War, the Fed bought an increasing share of Treasury debt relative to GDP, caused the price of gold to rise in markets above $35 an ounce of gold that the Fed was mandated to keep, induced the Bretton Woods countries to agree to suspend redemption of currency into gold by ordinary people, allowed redemption only by other central banks in Bretton Woods, and led to these other central banks buying up the US dollars to hold as excess reserves. This imported the US inflation into those other countries. It continued until France began cashing in US dollars for gold in 1971 and that ended the gold standard as Nixon closed the gold window at the Treasury. The Fed was not independent then.
Inflation rate targeting started in the 1978 Act was carried out by Volcker after Carter fired Miller after 11 months since inflation was still rising. Volcker succeeded in carrying out the 1983 target of 3% inflation, as stipulated in the 1978 Act (which stipulated 0% inflation from 1988 onwards). The Fed was briefly independent then.
This period of stability was ended with the terrorist attacks in 2001. Greenspan printed enough money to drive the short term market interest rates below the inflation rate for three years. Inflation steadily rose from 1% to 4% from 2002-2004, and then the Fed decided to quickly raise interest rates to “normalize” them: that is to make them higher than the inflation rate to yield a positive real interest rate. The Fed was not independent then.
The sudden unexpected increase in interest rates caused the 2008 financial collapse. Then the Fed again began printing so much money to finance the banking crisis Treasury expenditure that the Fed also began sterilizing freshly printed money by inducing banks to keep it as reserves by paying interest on reserves. This diverted the inflation tax revenue from the US Treasury (taxpayers) to private banks (a special interest group adversely affected by the bank panic). The Fed was not independent then.
In 2012 the Fed created a 2% inflation rate target in direct violation of the 1978 Act. It had printed so much money for so long with a 2% target murmured throughout central banks that the Fed did not bother to mention that this was illegal by US statutory Congressional law. The Fed was not independent then. Today, after printing so much money to finance Treasury spending during the pandemic, inflation is still high but falling. The Fed actively supported Treasury spending by increasing the inflation tax and allowing the President and Congress to avoid raising statutory taxes or to reduce spending. The Fed was not independent then or now.
Max Gillman 