Karen Petrou: Why the 1951 Fed-Treasury Accord Doesn’t Matter in 2024 (2024)

Later this month, FedFin will issue a brief assessing whether Fed independence is really at risk, taking into account not just what Donald Trump has said, but also what progressives and populists agree should be done to change the U.S. central bank’s governing law. As we’ve frequently noted, Donald Trump can talk tough about the Fed, but Congress has to agree to get tough before he can do anything but gradually change Fed leadership and hope his appointees do his bidding despite formidable resistance across the Fed’s entrenched institutional culture. The forthcoming brief will put much of the daily back-and-forth on this critical question into the often-missing context needed to understand how much risk the Fed really runs. However, I’ve gotten so many questions in the last few days following an American Banker article that I’ll answer a few of them now.

The questions revolve around the Fed-Treasury agreement in 1951 putting Treasury fully in the debt-pricing lane and keeping it out of Fed decisions setting monetary policy based on its macroeconomic judgment, not national fiscal or political demands. The question? It’s whether Treasury under Trump could revoke the 1951 Accord and regain control over monetary policy.

The best independent analysis of the history surrounding the 1951 Accord and its substance comes in a paper written in 2001 on the Accord’s fiftieth anniversary by staff at the Federal Reserve Bank of Richmond. It rightly puts the Accord squarely in the historical context necessary to understand if the 1951 Accord has contemporary import. As it turns out, what went around isn’t coming back.

Importantly, the Fed sacrificed its ability to stand aloof from fiscal policy during the darkest days of the Second World War, when the central bank heeded the importance of raising as much money as cheaply as possible to save the nation. Immediately after the war, the Fed began to act more independently, raising rates when post-war demand sparked inflation even price controls could not staunch.

The Truman Treasury and President Truman himself strongly opposed higher rates not only because they threatened Truman’s re-election in 1948, but also because they compounded pressing fiscal problems when the Korean War broke out in 1950. The White House again wanted lower borrowing costs to fund a war effort, but the Fed this time believed inflation posed as much a threat to national stability as the “Red Chinese.”

The war over Fed independence then began with guns blazing from 20^th and Constitution back and forth to Fifteenth and Pennsylvania with a few major skirmishes fought in between at the White House. President Truman was so insistent that the Fed heed Treasury’s demand for ultra-low rates that he wrote a furious demand that quickly became a public reproach of the Fed in Truman’s blunt, personal, damning style. Still unable to force the Fed to lower rates, Truman appointed a new Fed chair he thought would do his bidding, William McChesney Martin. Hailed as among the Fed’s best chairmen by those for whom Fed independence is beloved, Martin abandoned the pro-Treasury stand he pressed while at Treasury and turned into a fierce Fed defender as soon as he walked into the building. Years later, when Truman saw Martin on the street, he reportedly looked hard at him for a few moments, called him a “traitor,” and stalked off.

One could speculate about what the Fed might do if another national-security threat akin to World War II threatened. Or, less cataclysmically, perhaps Donald Trump can force Jay Powell to resign as Truman was able to do to a dissenting Fed chair in 1951. But these are remote and, one hopes, implausible scenarios with, one hopes again, no near-term bearing on whether the Fed would heed Mr. Trump if a Trump Treasury walks from the Accord. In truth, the Treasury-Fed Accord of 1951 does not matter in 2024.

The 1951 Accord includes only one minor Fed concession: a commitment to give Treasury an inside look at what it was going to do before it did it, with the Accord largely stating that Treasury now agreed with the Fed and that it and the President would leave the central bank to do its job as they tried their best to do theirs. As a result, Treasury walking away from the Accord means only that Treasury would lose the courtesies that the Fed has long accorded it, making fiscal policy still more challenging to execute.

Mr. Trump would be free to pressure the Fed as much as he wanted, but he wanted to pressure the Fed throughout the run-up to the 2020 election and the Fed paid him no more heed then than it’s likely to do if there’s no Accord telling Treasury and the President to mind their manners.

And, even if the Fed became obsequious, it now has a charter crafted in 1977 and 1978 that predicates a triple mandate: maximum “real” employment, price stability, and moderate long-term interest rates. Unless the President or Treasury wants more of any of these and persuades the Fed that their wish is the Fed’s command, the Fed can and will do what it wants unless or until Congress changes its mandate.

Might it do so? It could. Our forthcoming brief will lay out key legislative proposals and their chances of action. The odds are that the Fed will remain both the “only game in town” and its own umpire. But, that’s far from certain.

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