Arguments that the Fed needs direct oversight or that it should do what the president wants it to do betray a misunderstanding of what it means for a central bank to be independent and how monetary policy is crafted and carried out.
In my 20 years working at the Fed, first in New York where I helped implement monetary policy and then in Atlanta as the senior officer in charge of research, I learned that dealing with the unexpected is the day-to-day reality of the job. And it’s best if your hands aren’t tied.
If the Fed loses its independence, then its policy will become less sensitive to what’s going on in the real world and more of a hostage to people who know far less about designing and implementing monetary policy. I believe that would be a significant step backward and could run the risk of outright disaster.
What Fed ‘independence’ really means
Social scientists of all political persuasions no longer even debate the question of whether a country’s central bank should be independent.
They recognize the term refers only to how policy is implemented – free of political pressure – and that independence does not give the central bank the ability to set its own goals, as some lawmakers seem to think.
A good analogy is building a house. The owner takes part in drafting the plans but doesn’t worry which type of hammer is used. Similarly in an operating room, the surgeon must be able to quickly choose which scalpels and other instruments will help her save the patient. While she follows the guidelines learned in medical school and past clinical experience, there is no time for excessive deliberation when someone’s life – or the U.S. economy – is on the line.
Monetary policy is neither simple nor fixed
Some lawmakers’ demand for an audit or direct oversight rests on the notion that there is a simple way to carry out monetary policy, as if there was one rule to follow. In the economics profession, the discussion of sticking to policy rules has quieted down as economists learned, over and over, that constant changes in the way people and companies behave and continuous innovation undercut the foundation for rigid rules.
At first it looked as if this would work well. That is until everyone could “create money” on a whim using a credit card. Whenever you use credit to buy a new computer or pay for groceries you’re getting a bank to lend you “money” that did not exist a second ago but suddenly does.
Revise and rewrite
That unfolding situation threatened economic and financial stability and drove unemployment higher. In its wake, the Fed brought its target interest rate down to zero and greatly enlarged its purchases of longer-term mortgage-backed and government bonds. As a result, unemployment fell substantially and growth turned around. By the end of 2015, the Fed was able to begin very gradually raising rates. And last October, it began reducing the size of its greatly enlarged balance sheet.
Fed documents show long debates and a lot of disagreement about these very unconventional and untested policies. Arguably thanks to the Fed’s flexibility and policymakers’ willingness to adapt to new and unexpected circumstances, the U.S. economy has been growing steadily since 2009 and the unemployment rate hit an 18-year low in May.
Would results have improved had the Fed been subject to regular congressional audits of its procedures in real time? Or if the Fed had been subject to presidential or political pressures to change its decisions?
This is the worst idea of all.
Political tug of war
There’s always been a tug of war between politicians who typically want to juice up the economy in the short term to improve their polling numbers and central bankers who must think about long-term growth and financial stability. President Trump, for example, is attacking rising short-term interest rates – which, over time, may slow economic growth – just a few months before midterm elections.
They urge us to keep central banks independent of political meddling so that their purchases of government debt in financial markets are their own decisions and not the result of pressure to finance a growing government deficit. In the U.S., the Fed is not even permitted to buy debt directly from the U.S. Treasury, a department of the executive branch.
They also remind us that even in our age of transparency, it is not a good idea to broadcast information about banks or other financial institutions that may be close to failure. This is something that could easily result if the Fed were subject to congressional scrutiny because politicians have a history of leaking sensitive financial and other information for political gain.
Americans learned too much about panic during the Great Depression.
When your house is on fire
The Fed, certainly, could do a better job communicating what it does to the public and helping it understand how and why forecasts change as well as how ongoing innovation may affect its decisions.
But relying on politicians who worry mainly about getting re-elected is not the way to do this.
The Fed uses many different models of the economy and also assesses a ton of anecdotal information on evolving conditions in making policy decisions. Relying on an elected official like the president to make these decisions would not work. Nor would observing the Fed at work in real time or having Congress audit its policy procedures.
These are frightening proposals. On the latter, Americans should be well aware by now that Congress is not known for its flexibility and responsiveness.
If your house is on fire, would you appoint a study group to examine the causes and search for who may be at fault before you call 911? Similarly, in response to those who want to weaken the Fed because they’d like less regulation, do you think requiring smoke detectors when the public is at risk amounts to unnecessary government interference?
Our house would still be ashes from the last crisis if Congress or the president oversaw monetary policy. Let’s pray that never happens.