Tuesday, August 3, 2010

There Is No Such Thing As Central Bank Independence

. Tuesday, August 3, 2010

Not really. Economics of Contempt is puzzled about this. He should not be:

[W]hat's the point of having the independence they're so jealously guarding if they're not going to actually use it? Politicians are always going to say idiotic things, and populists are always going to claim that the Fed is in bed with the big banks. But if the mere threat of "political interference" is enough to circumscribe Fed policy, then is the Fed really "independent" in the first place?

Central banks are in principal-agent relationships with governments. If governments don't like what they are doing, they can remove authority from central banks. They only sense in which central banks are "independent" is that governments can make commitments not to interfere with them. Which has happened, to greater or lesser extent, in most developed countries. But when politicians are making loud noises about restricting the Fed's authority, auditing its activities, and when the current Fed chairman was barely re-approved just a few months ago, there is no reason for them to think the government has made any such commitment. That's what Dallas Fed president Richard Fisher is talking about here:

[W]e at the Fed must continue to comport ourselves in a manner that exorcises any lingering worries about our willingness to brook any political interference with our commitment to fostering price stability and maximum sustainable employment. We delivered on our duty to restore liquidity to the commercial paper, asset-backed securities, interbank lending and other markets. We then closed out all of our extraordinary liquidity facilities, doing so without costing the taxpayer a dime (imagine that: a government agency that closes programs after they have outlived their usefulness!). We have worked hard to earn the respect of the marketplace and of the nation, and we dare not risk it at a time when there is so much uncertainty elsewhere.

The Fed is a political, and politicized, institution. As it must be. This should not come as a surprise.


Economics of Contempt said...

I wasn't "puzzled" -- those were rhetorical questions. I'm well aware that the Fed isn't truly "independent," and that political independence exists along a continuum. I don't think that comes as a surprise to anyone familiar with the way our government is set up. When people talk about Fed independence, they're talking about the specific form of political independence that Congress has granted the Fed. Everyone understands that Congress can take this independence away if it so chooses.

Kindred Winecoff said...

Right. Which is why it's not surprising that the Fed is acting defensively. Congress has been discussing limiting or curtailing the Fed's activities because Congress is worried the Fed has over-stepped its bounds. The Fed is walking on egg-shells here, and it knows it. There's no way they could embark on a trillion-dollar QE campaign (as Sumner and Krugman would like) without tempting fate. Their recent statements and activities make much more sense in this light.

There Is No Such Thing As Central Bank Independence
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