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Saturday, January 20, 2007

Fed Independence

Here's George Will on Barney Frank and the Fed:

The Equality Engineer, by George F. Will, Commentary, Washington Post: Barney Frank, the 14-term Massachusetts congressman who chairs the House Financial Services Committee, says ... that Congress should "pay a little more attention" to the seven governors of the Federal Reserve system, all of whom are confirmed by Congress. The Fed, says Frank less mildly, should not be considered "above democracy": "We can debate whether Terri Schiavo's life should be recognized as over" and other fundamental questions of existence, "but God forbid anybody in elected office should talk about whether or not we need a 25-basis-point increase" in interest rates. "Somehow that's sacrosanct. No, it isn't. It's public policy."

The late Sen. William Proxmire, a populist Democrat who represented Wisconsin for 32 years, said that all members of Congress should have written on their bathroom mirrors, so it is the first thing they read each day, this: "The Fed is a creature of Congress." Frank says Congress should not intervene in monetary policy . . . "unless." By monitoring whether the Fed's governors act as they said they would when they were being confirmed, Congress would be "setting the predicate for intervention if they act otherwise."...

I believe that any erosion in independence of the Fed in favor of more legislative or executive branch influence over monetary policy would make us worse off. Yes, the Fed has made mistakes in the past, but those mistakes had the potential to be far worse if policy had been in the hands of politicians. For example, Barney Frank's past statements about the Fed's adoption of an explicit inflation target make me wonder if he fully understands the theoretical underpinnings of inflation targeting. The Fed is taking a very careful, very deliberative approach to the adoption of an inflation target and if they decide to adopt one, it would be a mistake for Congress to block the action, as has been threatened, based upon a faulty understanding of the reasons for the change in policy. In fairness though, Frank has backed off a bit on this point and his more recent statements have shown some progress in understanding the reasons for the adoption of a target, i.e. he is realizing that inflation stability is not a goal in and of itself, it's a means to an end (output and employment stability).

I have no problem at all with people, including legislators, giving their opinion on what monetary policy should be. We should all be free to say what we believe. But it crosses the line to start saying "The Fed is a creature of Congress", that 'Congress should not intervene in monetary policy . . . "unless,"' and that they are "setting the predicate for intervention if they act otherwise." Threatening to take away independence of the Fed is an attempt to influence policy in a particular direction, and it has the potential to undermine the institution. I hope Barney Frank and others will be careful to respect the boundaries between Congress and the Fed. I can imagine situations where it would be appropriate for Congress to step in, but we are not even close to that point and unless and until we get there, the Fed's independence should be respected. Frank did say that his committee has "a larger jurisdiction to talk than to legislate" and I hope he abides by that statement.

One more thing. I have heard a lot of criticism of Ben Bernanke lately, I have made a few comments myself. Some of the criticism is over the direction of policy, and some of it is related to his appearing to represent the administration's position on matters such as the budget deficit.

The Fed is structured to bring various interests to the discussion and implementation of monetary policy. The intent is to bring different geographical interests to the table (the northeast may be booming while the south is in recession  - what should policy be?), and to represent the interests of businesses, the financial sector, and the general public. In addition, there is an interest in coordinating monetary and fiscal policy so that they don't fight against each other (and they can, when Bush contemplated tax cuts, Greenspan explained that if they overheated the economy, then the Fed would have to raise interest rates to undo their stimulative effect). For this and other reasons, the executive branch is given influence at the policy-making table as well. This comes through the Fed Chair - the Chair is selected by the president and serves a four year renewable term. The Chair meets with the president and the administration on a regular basis, I believe around once a week currently, to discuss policy. If the president is displeased with how the Fed Chair conducts policy, there is no obligation to renew the Chair for another four-year term once the current term expires. So the Chair, unlike the other members of the FOMC, has an interest in cooperating with the president's wishes.

So it is to be expected that the Chair will reflect the administration's politics and preferred policies. However, in the end the Chair is independent. Though a Chair typically resigns if a term is not renewed, there is no obligation to do so. If Bernanke's term as Fed Chair is not renewed, he can still serve out his full seventeen year term. He'll still be on the Board, if he wishes, long after the current president is gone and his job will be much easier if the economy is doing well many years down the road giving him an interest in the economy's long-run performance. And of course, and more importantly, he'll have a better chance of keeping his job as Chair when the next president comes aboard if the economy does well which gives him an interest in the economy's performance that extends beyond the current administration. Thus, while the Fed Chair is subject to influence from the president, there remains strong incentives to do what's best in the long-run rather than what's best for a particular president.

Our politics may differ, but when it comes to monetary policy I have faith that Ben Bernanke and others on the FOMC have nothing but the best interest of the country in mind when they set monetary policy. I may disagree with their decisions, and I make it clear when I do, but I don't doubt they are doing their best to achieve the mandated goals of output and price stability.

    Posted by on Saturday, January 20, 2007 at 12:55 PM in Economics, Monetary Policy, Politics | Permalink  TrackBack (1)  Comments (35)


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    » Fed Independence II from Economist's View

    As an addendum to the post below this one, here's more on Fed independence. This is from Chapter 12, Central Banking and the Conduct of Monetary Policy, of the textbook of our newest Federal Reserve Governor, Frederic Mishkin, discussing the [Read More]

    Tracked on Sunday, January 21, 2007 at 03:10 AM


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