- The Federal Reserve has never been free of political pressure, but it has changed how it deals with it.
- Due to the novel coronavirus, the Fed has been working more closely with the government.
- But the Fed’s independence is paramount because it gives us apolitical policy making.
- Simon W. Bowmaker is Clinical Professor of Economics at the NYU Stern School of Business.
- Paul Wachtel is a Professor of Economics at the NYU Stern School of Business.
- This is an opinion column. The thoughts expressed are those of the author.
- Visit Business Insider’s homepage for more stories.
Central bank independence — the ability of central bankers to make policy without interference from political authorities — became the holy grail of monetary economists in the 1990s. It was agreed that independence from political pressure was the bulwark that protected the world’s economies from inflation.
But this universal truth was challenged by the financial crisis a decade ago and seems to have crumbled in the face of the COVID-19 pandemic.
The Federal Reserve, along with other central banks, has jumped the barrier and is now working hand-in-hand with the government, doing things at the behest of Congress and, indeed, acting as the allocator of loans to the private sector for the government. Central bank independence appears to have gone up in flames.
But if you dig deeper…
Fed independence is alive, and more important than ever
Although Fed policy actions are now hard to distinguish from fiscal policy, the independence of the Fed as an institution is more important than ever.
Fed Chair Jerome Powell’s thoughtful responses at the news conference following the most recent meeting of the Fed’s all-important interest rate setting committee — the FOMC — and the economic projections made by the FOMC participants underlined this point.
The FOMC projected a slow economic recovery that reflects the lasting damage from the COVID-19 crisis. This gloomy forecast runs in stark contrast to the upbeat message coming from the Trump administration — which understandably does not take its eye off the election — and shows that the president’s concerns about November still do not factor into the Fed’s thinking.
The Fed has never been free from pressure, but it has changed how it deals with it
A look back in history tells us very quickly that the Federal Reserve has never been completely insulated from political influence.
President Truman tried to force the hand of the Fed and reached an agreement only after a bitter public dispute. President Nixon was able to get the chair of the Fed to use monetary policy to assist in his reelection.
A decade ago, as the financial crisis descended, the government’s response was hammered out in meetings between Treasury Secretary Paulson and Fed Chair Bernanke. And, Dodd-Frank — the post-crisis mega financial reform bill —introduced several programs and procedures that either reduce the Fed’s ability to act on its own or require Treasury approval for certain crisis responses.
One might wonder whether Arthur Laffer, a Trump advisor who was awarded the Presidential Medal of Freedom by the president last year, was on to something when he told one of us for the book When the President Calls: “I don’t think the Fed should be independent…you must have accountability for anything as powerful as the Fed.” Laffer’s observation was part of a rant against the chair at the time, Janet Yellen, and academic economists in general.
Few would agree with Laffer, but it’s clear that his sentiment has some sway. Over the years, transparency regarding the Fed’s policy actions and accountability to the public and Congress have increased enormously. The days when changes in the policy interest rate were kept secret in order to avoid upsetting Wall Street are long gone.
The Fed chair makes regular public statements and holds regular press conferences, all of which make the central bank one of the more open and transparent agencies in the Trump administration. Indeed, in a recent interview with Princeton professor Alan Blinder, Jerome Powell said: “this precious grant of independence … comes [with] the obligation of transparency and accountability.”
Coordinating, while remaining independent
The Fed’s response to the COVID-19 shutdown has made it a close partner of the government. Lending is no longer restricted to financial institutions, which was largely the case in the financial crisis and consistent with the traditional central bank role of the lender of last resort to banks. Today the Fed is about to open up its own lending facility to medium-sized businesses and provides a backstop for bank lending to small businesses.
Crisis brings the central bank out of its cocoon and places monetary and financial policy at the heart of the government’s response and clouds the distinction between central bank lending and government expenditures.
Nicholas Brady, Treasury Secretary for George HW Bush said in When the President Calls: “I feel strongly that the Treasury Department and the Federal Reserve can operate together for the benefit of the public.” Nevertheless, he and Fed Chair Alan Greenspan had a serious difference of opinion in 1992. Brady thought the Fed should be easing monetary policy; Greenspan disagreed, and Brady believed that Fed policy contributed to Bush 41 not winning re-election.
Still there are important reasons why central bank independence is paramount, particularly in a crisis situation. Janet Yellen, before she became Fed chair, said in the same book: “We have the advantage of a huge professional staff who can do work in a very thorough, analytic, and thoughtful way; and there is time to debate things more carefully than is possible sometimes in a White House setting.”
Central bank independence is therefore important — even as the crisis pulls the Fed closer to the government —because it gives us thoughtful, apolitical, professional, and generally respected economic policy making.
Fed policy has not only been the right thing to address the collapse in economic activity, Fed independence has bolstered confidence in the American prospect. Just compare the public’s confidence and hopefulness regarding our economic policies in the last three months to public health policies provided by executive branch agencies like the Centers for Disease Control and Prevention, where professionalism built up over many years has been crippled by politicization that comes with direct executive control.
Central bank independence — the ability to guide policy with a clear professional message, transparently and with procedures for accountability — has never been more important to our future as a nation.
Simon W. Bowmaker is Clinical Professor of Economics at the Stern School of Business, New York University, and Visiting Senior Fellow at the London School of Economics and Political Science.
Paul Wachtel is a Professor of Economics at New York University Stern School of Business. He teaches courses in monetary policy, banking and central banking, and global macroeconomics.