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Thursday, September 20, 2007

"The Semantics of Fed Independence"

On Fed independence:

Perspectives on Federal Reserve Independence—A Changing Structure for Changing Times, by Bruce K. Mac Laury, FRB Minneapolis: ...The Semantics of Fed Independence Quite probably the term “independence” has been over-used. It was a key concept in the design of our central banking system—but in a relative sense, not as an absolute.

What does “independence” mean? Is the Federal Reserve accountable? Is it responsive to changing national priorities?

First, let's be clear on what independence does not mean.

It does not mean decisions and actions made without accountability. By law and by established procedures, the System is clearly accountable to congress—not only for its monetary policy actions, but also for its regulatory responsibilities and for services to banks and to the public.

Nor does independence mean that monetary policy actions should be free from public discussion and criticism—by members of congress, by professional economists in and out of government, by financial, business, and community leaders, and by informed citizens.

Nor does it mean that the Fed is independent of the government. Although closely interfaced with commercial banking, the Fed is clearly a public institution, functioning within a discipline of responsibility to the “public-interest.” It has a degree of independence within the government—which is quite different from being independent of government.

Thus, the Federal Reserve System is more appropriately thought of as being “insulated” from, rather than independent of, political—government and banking—special interest pressures. Through their 14-year terms and staggered appointments, for example, members of the Board of Governors are insulated from being dependent on or beholden to the current administration or party in power. In this and in other ways, then, the monetary process is insulated—but not isolated—from these influences.

In a functional sense, the insulated structure enables monetary policy makers to look beyond short-term pressures and political expedients whenever the long-term goals of sustainable growth and stable prices may require “unpopular” policy actions. Monetary judgments must be able to weigh as objectively as possible the merit of short-term expedients against long-term consequences—in the on-going public interest.

There's evidence to support the view that 'insulation" leads to better economic outcomes, and I think we should be very careful about compromising the Fed's ability to act independently of the rest of government.

    Posted by on Thursday, September 20, 2007 at 12:15 AM in Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (4)

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