Central Bank Independence in the US and other Countries

Willem Buiter says "the US has become one of the least operationally independent of the central banks in the industrial world":

A Fed Chairman's lot is not a happy one (happy one), by Willem Buiter: Flanked by Christopher Dodd, Chairman of the US Senate’s Banking Committee ... and by Hank Paulson, US Treasury Secretary, Fed Chairman Ben Bernanke looked more like a Taliban hostage than an independent central banker at his August 21 meeting in Dodd’s office. The letter from Bernanke to Senator Charles Schumer, circulated around Washington DC on Wednesday August 29, 2007, in which the Governor of the Federal Reserve offered reassurances that the Federal Reserve was “closely monitoring developments” in financial markets, and was “prepared to act” if required, reinforces the sense of a Fed leant upon and even pushed around by the forces of populism and special interest representation.

This is not a new phenomenon. With the explosion of operationally independent central banks since the New Zealand experiment of 1989, the US has become one of the least operationally independent of the central banks in the industrial world. Only the Bank of Japan is, I believe, even more readily influenced by political pressures...

[T]he fact that the Fed is a creature of Congress, and can be abolished or effectively amended out of existence with simple majorities in both Houses, has acted as a significant constraint on what the Fed can do and say. ...

To illustrate the difference between the degree of operational independence of the Fed and the ECB, consider the inflation target. The ECB has price stability as its primary target. Without prejudice to price stability, it can pursue all things bright and beautiful, and is indeed mandated to do so. All this is in the Treaty. There is, however, no quantitative, numerical inflation target in the Treaty. Nor does the Treaty spell out which institution should set such at target, if there were to be one. So the ECB just went ahead and declared that an annual inflation rate of just below but close to 2 percent per annum on the CPI index, would be compatible with price stability. Neither the European Parliament, nor the Council of Ministers were consulted.

The Federal Reserve Act has stable prices as one of the ... goals of monetary policy. ... Could the Fed do what the ECB did, and specify a numerical inflation target? Most certainly not. Congress would not stand for it.

Politically, the job of Chairman of the Fed is therefore much more difficult than that of the ECB or even the Bank of England. Strong Chairmen, like Paul Volcker and Ben Bernanke, manage to create a larger choice set for the Fed than a weak Chairman like Alan Greenspan, but even the most independent-minded and strong-willed Fed Chairman is much more subject to political influences and constraints than the President of the ECB or the Governor of the Bank of England.

Both populism and special interest representation are key driving forces in the US Congress. Preventing large numbers of foreclosures on madcap home mortgages taken out especially since 2003, unites the forces of populism and special interest representation, although they tend to part company when it comes to who will pay the bill for the bail-out. ...

Policy rate cuts are justified if and only if the legally mandated objectives of the monetary authority require it. ... Credit crunches and liquidity crises therefore matter only to the extent that they affect these ... goals, now or in the future. Fortunately, instruments exist with which credit squeezes and liquidity crises can be addressed effectively, and without creating moral hazard (such as the MMLR at punitive prices described above) that do not involve changing the monetary policy rate.

I hope and expect that if and when the Fed perceives that real economic activity is likely to weaken materially going forward and/or that inflation is likely to undershoot its comfort zone ..., rates will be cut decisively and without delay.

I also fear and expect that, because of the relentless pressure being brought to bear on the Fed by all branches of the Federal Government (with the exception, as far as I know, of the Supreme Court), the Fed will be convinced to cut the Federal Funds target rate, probably as soon as the September meeting. I fear this could be not because this is the best way to guarantee the optimal trade-off between its three macroeconomic goals, but because this is the only way to salvage some measure of future independence for the Fed, in the face of irresistible pressure for a cut now from a lobby for a lower Federal Funds rate that includes special interests ranging from low income households unable to service their wildly inappropriate mortgages to extremely high net worth hedge fund managers facing massive losses and early retirement.

I hope I’m wrong on the last point.

Just one comment. In the US, the intent is not for the Fed to be completely politically independent, there are mechansims in place that allow various political interests be represented in the deliberations over monetary policy. Though power has been centralized over time so that some of these mechansims are now relatively weak, the set up of the system tries to ensure that banking, business, and the public interests are repersented on the monetary policy committee, that power is distributed geographically, and the structure is such that the executive branch has political influence over the chair of the Fed (e.g. four year terms). Whether or not this is the best way to set up the central bank is something to consider - I favor more independence than we have now - but the fact that there is political influence and representation is not at odds with the design of the Federal Reserve system.

Comments

[spencer]

The Fed is independent in the government,
not independent of the government.

Like the Supreme Court, it reads election results.

[Brenda Rosser]

"..Could the Fed do what the ECB did, and specify a numerical inflation target? Most certainly not. Congress would not stand for it..."

The setting of a purely monetary target for inflation would be extremely dangerous for the integrity of the natural environment and for the working and living conditions of the poor.

I wish that the word 'inflation' was always preceded by the word 'monetary'. That way, it would always be clear that loss of 'real' value only pertains to loss of purchasing power and nothing more than that.

Right now we live in a world with less available arable land, less drinkable water, less grain to feed the population, far fewer native forests, deteriorating working conditions. Even if we didn't experience an increase in the available global currencies there is, in effect, less available real (valuable) wealth to purchase with each unit of currency.

Economists should encourage enconomies in all senses of the word.

[Winslow R.]

Mark wrote: "- I favor more independence than we have now - but the fact that there is political influence and representation is not at odds with the design of the Federal Reserve system."

I interpret this to mean the current 'faulty' design of the Federal Reserves system makes independence currently impossible.

Until the Fed is capable of being truly transparent with a politically agreed upon taylor rule based reaction function to inflation and unemployment that actually works and does not require 'fed intervention' at times of crisis, they are 'stuck' with political oversight.

Someone needs to monitor their 'tinkering'. It seems politics are starting to direct the type of 'tinkering' to be done. Until the system has a major break down, the bones of the system will not be examined and redesigned, just look at Japan - a financially engineered mutant in a perpetual zombie state.

[Bruce Wilder]

"Strong Chairmen, like Paul Volcker and Ben Bernanke, manage to create a larger choice set for the Fed than a weak Chairman like Alan Greenspan . . ."

Huh?

[Bruce Wilder]

BR: "Right now we live in a world with less available . . . "

I strongly agree that we badly need an economic term for rising costs due to congestive exhaustion of the commons.

I think the dictum that [monetary] "inflation is always and everywhere a monetary phenomenon" is a good one. But, it leaves aside another, important economic phenomenon, which seems likely to dominate this century. We should not get them confused.

[Winslow R.]

BW wrote: "I strongly agree that we badly need an economic term for rising costs due to congestive exhaustion of the commons."

Which would indicate...

" As such, it illustrates how an "invisible hand" (laissez-faire) approach to resource problems will not always provide the expected optimal solution. In Hardin's hypothetical commons, the actions of self-interested individuals do not promote the public good, and Adam Smith's invisible hand does not ratchet toward higher utility.......Hardin argues against the reliance on conscience as a means of policing commons, suggesting that this favours selfish individuals over those more far-sighted."

http://en.wikipedia.org/wiki/Tragedy_of_the_commons

But perhaps we have a bit of this....?

"The tragedy of the anticommons is a situation where rational individuals (acting separately) collectively waste a given resource by under-utilizing it. This happens when so many individuals have rights of exclusion (such as property rights) of a resource that the transaction costs of coordinating those rights overwhelm any previously existing benefit. "

http://en.wikipedia.org/wiki/Tragedy_of_the_anticommons

[Winslow R.]

Net farm income to surge 48%, USDA says

"Farming may be the healthiest sector of the economy."

http://www.chicagotribune.com/business/chi-fri_farm_0831aug31,0,5422246.story

Next story, banker's become farmers...

So Mark how's the family doing?

[billy]

Is the Fed going to announce which is the next bubble its going to blow? Or is it only wink-nod to the IB's and hedgies?

[Meh]

I'm too lazy to precis Buiter's history and ideology, but if you are interested in this issue, you owe it to yourself to google it and see where his biases lie.

The particular bias I will note is that he stamps his feet about Congressional influence on the Bank, but seems to ignore the history of Greenspan who was rather more influenced by various Presidents than Congress.

[robertdfeinman]

I disagree with the intent of the way the Fed was set up. By giving members 14 year terms the idea was that they would be independent of political pressure (just like judges who have long terms).

I can't remember about Volcker, but I always felt that the chummy relation between Greenspan and the whitehouse was inappropriate. It's one thing to coordinate policies, or to give a heads up about intended moves, it's another to hobnob with GOP political operatives like Rove.

As far as I'm concerned this is just another in the never-ending series of examples of the politicization of everything by this admin.

How about this one, from today:
HHS toned down a campaign to promote breast feeding after the infant formula industry complained to the whitehouse that it would cut into their sales. Is there no limit to how low these people will sink? Does anyone care?

[Winslow R.]

So much for transparency...

"The Bank of England has warned financial institutions authorised to use its emergency lending facility that they are not supposed to discuss it publicly."

http://www.ft.com/cms/s/0/9004b03a-5728-11dc-9a3a-0000779fd2ac.html

[dd]

Want to thank Timothy Geithner for managing things as well as can be managed given the unpredictable impossibilities (also thank you Mark for this forum). The perceived pressures matter not a whit; as the real pressures are far more perilous; but so far so good.

[calmo]

Thank you rdf for this line:

As far as I'm concerned this is just another in the never-ending series of examples of the politicization of everything by this admin.

which sounds like O'Neill in Suskind's Loyalty and cannot be repeated enough.
The composition of the current Fed is very lopsidedly GOP. But for a body whose mandate mentions employment, there has never been a representative of labor...not that the current Secretary of Labor has any relevant experience either.

Hard to digest the view that the Fed will not represent those who benefit from the current structure (not the Texas janitors) and support instead those who have been exploited and misled.