Central Bank Independence is Overrated

Central Banks, should they exist, should be able to do what is right for monetary policy, which includes regulation of credit.  In a fiat money world, where credit exists as electronic entries, credit is money.

But wait, what if central bank independence is compromised from within?  What if voluntarily becomes the lap dog of the President, Treasury, or Congress?

It takes a bold man to stand up to the powers that be, and the Fed has had its share of them.  Marriner Eccles opposed Truman.  William McChesney Martin, Jr. stood up to Presidents and Congress for his long term as Chairman.  Paul Volcker blew cigar smoke at representatives and Senators as he restored sound money to the US amid screams of pain in the economy.

Central bank independence doesn’t mean squat unless the central bank uses it!

In the name of independence, for fear that the President or Congress would restrict the central bank, many Fed Chairmen have given in to the powers that be:

  • Ben Bernanke, rescued entities that he should not have rescued, and established lending programs that use the national credit to benefit a minority of participants.  These actions should have been taken by Congress, if done at all, so that the voters could decide whether it was right to do it or not.  Bernanke validates the idea that the government keeps the Fed around to do what it cannot do constitutionally.
  • Alan Greenspan threw liquidity at every little and big problem, and was slow to withdraw liquidity, pushing the US slowly but surely into a liquidity trap, which Ben Bernanke was saddled with.
  • G. William Miller and Arthur F. Burns, who facilitated the inflation of the ’70s, at the behest of Nixon and Carter.
  • Daniel R. Crissinger and Roy A. Young, who facilitated the loose monetary policy of the ’20s.

Central bank independence means risking your own tenure for the good of the institution.  Marriner Eccles and Paul Volcker did not get reappointed because they offended the President.    Central bank independence does not mean compromising in order to protect against micromanagement.  Independence means being a man, and telling the President and congressmen that you will do what is right to preserve sound money, regardless of the consequences.

The Fed as Systemic Risk Regulator

I have suggested in the past that the Fed should regulate systemic risk as an aspect of its mandate only because they are the biggest creator of systemic risk through loose monetary policy.  I am not suggesting this on the basis of competence — that is ridiculous.  But on the basis of modifying the behavior of the Fed to make it more resistant to loosening rates early because of systemic risk concerns — that makes sense, because it will increase the emphasis on a sound currency.

Now, many economists are pleading with Congress to be gentle on the Fed because an independent Fed is critical to sound economic policy.  That would be true if the Fed were willing to take politically unpopular actions that were in the best interests of the economy.  Sadly, that is not true of the present Fed.  They do what the politicians want, and give the politicians cover, because the politicians can point at the Fed as the actor, via the rubric of “Central Bank independence.”

I say that the Fed needs more accountability and transparency to Congress, and ultimately to the American.  The quasi-public, quasi-private nature of the Fed needs to be changed to public or private.  Section 13.3 of the Federal Reserve Act, which allowed for the most egregious bailout actions, should be repealed. If bailouts need to be done, let Congress do them, and let them take the heat for their actions.

Not only should the Fed be audited as any large public or private organization, but if they are a public organization they should respond to the FOIA requests from major news organizations (Bloomberg, Fox Business, etc.) without hiding behind technicalities of protecting business secrets.  The insurance industry regularly reveals detailed data on their operating companies, with little seeming harm.  The banks can afford to do the same.

Power without accountability should be foreign to our republican form of government.  Control of our currency rightfully belongs to Congress, and Congress should tighten controls on the Fed so that its degree of independence is limited to the ordinary matters pertaining to a central bank — preserving the soundness of the currency.  Its competence there has been limited; but hey, at least focus on the basics would restore confidence in an institution that no longer has the confidence of the American people.

“Central Bank independence” is a nice phrase, but to the economists who petitioned Congress to preserve the status quo, I would simply ask this: How and from what should the central bank be independent?  To whom and in what ways should it be accountable?


  • matt says:

    Independence is overstated. When you have someone like Jamie Dimon sitting on the board of directors for the New York Fed at a time when, “Sure, JPMorgan would love to take over Bear Stearns… if the New York Fed agrees to foot the first 30 billion in losses.” Yeah, really independent.

    And that is not to mention that the Federal Reserve is, by its charter, not independent from the banks. There’s no better deal than being able to borrow at about 0% and turn the money around into low risk assets.

  • Lord says:

    Sound currency is not the only duty of the Fed. Congress also dispatched to it the duty of maintaining a strong economy and employment. Who are you to tell congress how to do its job? Who are you to presume the Feds actions don’t represent independence? I understand your argument about accountability and independence but in the end they are accountable to congress and the request for independence is at most a plea not to interfere in what they have judged to be mostly correct actions. Others would have it abolished. Congress can judge what it wants to do.

  • q says:

    you sure that bernanke has been caving to political pressure? i think he believes in what he is doing, as what he is doing is completely consistent with what his academic work pre-Fed.

    • q — with respect to liquidity programs, I agree, but with respect to Bear, the GSEs and AIG, I don’t. Bernanke’s hand was forced in those situations, and even he has admitted a dislike for those actions in later interviews.

      Lord — I believe the “double mandate” helps drive systemic risk levels higher, as policy accomodation get applied earlier, bigger and longer than it should. Ultimately unemployment levels are not affected by monetary policy in the long-run — those are more a factor of regulatory policies that would affect the hypothetical “full employment” level.

      Who am I to speak? Nobody but a voter, and an economist that predicted this crisis, unlike most, even though I was wrong about the size — it is bigger than I projected at first, and smaller than what I currently project.

  • q says:

    at least with respect to AIG, he hasn’t said anything that would lead me to believe that he didn’t favor the bailout. yes, he feels badly about it, and yes i think he held his nose, but i think he did it on principle.

    i think the principle was that he wanted to avoid a debt-deflationary depression.

    i doubt though that we would get a direct statement like ‘i argued against it but did it anyway’ even if it was so.