Federal Reserve's Independence?

One of the common claims made by opponents of the Audit the Fed bill is that passing the Audit would somehow compromise the Fed's independence. The problem with that argument is that it assumes the Fed is independent. In fact, the Fed has a long and shameful history of bowing to pressure from the Executive branch. Former Federal Reserve official Richard Alford is among those who has debunked the notion of the central bank's independence. In 2008 (before the stock market meltdown and the rise of a grassroots movement lead by Ron Paul and Campaign for Liberty), the left-leaning blog Naked Capitalism presented some of Alford's work on the decline and fall of Fed independence:

Few have any memory of America’s central bank having a openly contentious relationship with the Treasury and Congress. Even though Paul Volcker had to withstand considerable pressure, some of his predecessors fought open turf wars. Yet from the end of World War II to the (sadly) supine Arthur Burns era, there were not infrequent pitched battles with the Fed with incidents that would seem unthinkable now. For example, Truman summoned the FOMC to pressure them into a more accommodative policy during the Korean War, then issued a White House press release claiming the Fed had made a commitment that it had not agreed to. The Fed played hardball, leaking its version of the meeting, which contradicted the press release. That led Congress to join the fray, trying to bring the Fed to heel via sharply critical hearings. While Volker did endure widespread criticism and harangues from Congress, even for those who lived through that era. the memories of the ritual roughings up are dim. In addition, there was at least initial support for his harsh measures. Moreover, (unbeknownst to me) Volcker was masterful at defanging Congress long enough for his remedies to take hold. Had someone less adept been at the helm, a firefight might well have ensued.


Assuming for the moment that the Fed either made an error of commission (spiking the punch bowl) or omission (failure to exercise its regulatory and supervisory powers), is there any reason to believe it was the result of an erosion of the independence of the Fed? Unfortunately, the public record suggests that Fed independence has been compromised. There is reason to believe that Greenspan entered into deals with two of the three administrations during his tenure as Chairman. Some commentators believe that he entered into deals with all three. However, the number is unimportant. What is important is that the Fed’s independence was compromised and a very public precedent was set. Never again will an FOMC Chairman be able to say “The Fed does not make deals” to a President or a Secretary of the Treasury or a member of Congress. Compare the behavior of the Chairmen of the 1950s and Volcker to that of Greenspan. Chairman Eccles and McCabe both lost their Chairmanships because they wouldn’t compromise Fed independence. They stood their ground even after being summoned to the White House. Martin, appointed by Truman, was in later life referred to by Truman as “the traitor” presumably for taking the punch bowl away. The public image of Volcker is that of a man who twice a year endured public Congressional assaults, resisted political pressure, and enabled the Fed to stay the course. Greenspan, on the other hand, jumped at the chance to meet Clinton, traveling to Little Rock before the inauguration. Bob Woodward in his book “Maestro” quotes Clinton telling Gore after the pre-inauguration meeting: “We can do business.” Woodward also quotes Secretary of the Treasury Bentsen telling Clinton that they had effectively reached a “gentleman’s agreement” with Greenspan. The agreement evidently involved Greenspan’s support for budget deficit reduction financed in part by tax increases. It is not clear what Greenspan received. Even if the deal with Clinton contributed to a good policy mix, Greenspan should never have entered into that agreement/deal/understanding or another agreement/deal/understanding. The very act of negotiating and injecting the Fed into a discussion of budget decisions compromised Fed independence. Why shouldn’t Bush have expected the same? Why shouldn’t every succeeding President expect the Fed Chairman to be a “business” partner? Refusal to deal on the part of the Fed can no longer be attributed to principle and precedent. Refusal “ to do business” will now be viewed as a rejection, partisan or otherwise. The Fed is no longer able to stand apart from political battles. Greenspan severely compromised the Fed standing as an agency insulated from the short-sighted and partisan politics of Washington DC. Greenspan risked the NASDAQ bubble during the Clinton years (part of the quo for the quid?) and more recently implicitly accepted the risk of a housing bubble as he touted ARMs as the Bush Administration and Congress promoted the ownership society. Financial innovation was lauded while it produced short-term gains. The Fed failed to adequately pursue its regulatory responsibilities as it kept rates low, despite the relatively high levels of leverage, derivatives markets that dwarfed the underlying cash markets, breakdowns in lending standards and credit spreads that even it didn’t think compensated for the risks. Like Greenspan, the current Fed implicitly decided to risk long term stability rather than incur short-term costs. With globalization holding down measured inflation, it seems that no risk was not worth taking. After failing to use the independence granted to it by statute, the Fed is now pushing the bounds of its legal authority. It is making decisions that might better be reserved for elected officials. It argues that these steps are necessary, but the Fed is being drawn into the micro management of credit allocation and income re-distribution — a far cry from “inflation targeting”. The Fed is willingly injecting itself into areas that are the provenance of the Congress. Congress has not objected yet, but it will when it is to Congress’s advantage. Will it have costs? How does monetary policy designed by the people responsible for the tax code, fiscal deficit and Federal debt sound? Greenspan had very considerable political skills, but he did not use them to maintain Fed independence or insulate the Fed as it took policy steps that imposed short-term costs. He curried political favor and opined on issues other than monetary policy. There is no evidence that Bernanke made a deal. Bernanke also made it clear that unlike Greenspan he would refrain from commenting on issues other than monetary policy, but there is evidence that it was too late and that the Fed is “in play”. Recent behavior, first by the Administration and now by the Senate, indicates that positions on the Board of Governors are to be treated as patronage jobs doled out to party loyalists. The qualifications of a recent appointment look to be entirely political. Dodd’s refusal to consider confirming any appointments until after the next election is just as egregious, especially when one considers the depleted Board, soon to be down to three (2 if one assumes that Bernanke will retire when he isn’t reappointed Chairman.), and the challenges facing the Fed.

Read the whole piece here. (Remember this is a left-wing site so be prepared for some economic fallacies.) Also read Naked Capitalism on Audit the Fed bill here. If you have not yet done so, please call your Representative and Senators and tell them to cosponsor Audit the Fed (S. 16/H.R. 24).

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