ECON430-Topic #4: Fed Independence and the Dual Mandate

Fed independence has come under pressure recently after the onset of the Fed’s QE2 program. New leadership in the House of Representatives might lead to stripping of some authorities from the Federal Reserve. President Obama has pledged to keep out of the Fed’s affairs, largely leaving monetary policy to the central bank. Recently in Japan, similar calls for reduced BoJ independence have been made. Even in the U.K. the Bank of England’s independence has been questioned. There have also been calls by some politicians to remove the Fed’s “dual mandate” and replace them with a strict inflation targeting policy.

  • What do you believe would happen to the Fed if they were forced to explain their monetary policy actions in more detail. This is another way of saying that some politicians want to “audit the Fed.”
  • Do you believe that pressure on central bank independence will alleviate if and when economic conditions improve? Or do you believe that the central bankers will take much of the blame for the build up and collapse in the recent recession.
  • Do you believe stripping the Fed of its ‘dual mandate’ would result in a more stable economy? Or do you believe taking discretion away from the central bank would create more chaos.

Keep in mind here that the Fed itself is not even 100 years old, and that fiat money which is controlled by a central bank is really still very young. Look back at previous calls to end the Fed or strip its powers. Andrew Jackson spent many years fighting the idea of central banking eventually eliminating the shell of a central bank that existed at the time.

  • Do you think that the “independent central bank” is in danger of disappearing?
  • Should rules be set to manage monetary policy? If so, what or who would help out in times of crisis if you even think anyone should intervene. You might consider the case of Iceland to examine the aftermath of not bailing out the banking system as many other countries have done.

Inflation expectations have been either cited as on the rise in the U.S. while in China they are continuing efforts at stabilizing expectations.

20 thoughts on “ECON430-Topic #4: Fed Independence and the Dual Mandate”

  1. The politicians need to stay out of the Feds way. Although the Fed can leave an everyday citizen confused or unsure of the Fed’s goals, it is just because of the nature of the system. When announcing policy decisions or thoughts on where the Fed would like to take the economy they announce very broad measures, such as to target higher inflation. How much higher? No one really knows an exact figure. Also people working for the Fed and making these decisions are educated economists; they are not educated in law and politics like members of Congress. If policies implemented by the Fed did lead to a “quick” recovery then people would back off and not care what the Fed did, just like they did when the Bush administration was pushing for everyone to own their own home that caused the housing bubble that exploded at the beginning of this recession. It is in my opinion that the Fed is not in trouble of being stripped of any of its powers or disappearing. They have a very difficult task ahead of them but let the economists work on the economy and the politicians work on politics.

  2. It seems that the chairman of the DPJ’s fiscal and finance policy panel hit it on the nose, “We can’t expect Japan’s economy to overcome its difficulties just because the law is revised — the issues aren’t so simple [1].” I believe this statement can be used when examining the current criticisms of the issues of American monetary policy. Creating policy to strip the Fed of its independence seems hasty. With so much uncertainty surrounding monetary policy measures, how could it be certain that auditing the Fed would have positive results? Ambiguity still surrounds the actually effects of QE2; whether it can be considered the “scapegoat” for continuing problems in the economy or if its effects are so minute that QE2 does not even deserve the attention it has received [2]. It does not seem the right direction to pursue the regulation of an institution that has been around for 100 years and make it answer to politicians who aren’t on anybody’s “nice list” as it is anyway. Firing the coach in the midst of a bad season may have instant short-term success, but that usually never equates to long-term stability. Pressuring and changing the mandate of the Fed now could cause even more issues in the future.

    [1] http://www.bloomberg.com/news/2010-11-29/reducing-boj-s-independence-won-t-help-overcome-deflation-dpj-member-says.html
    [2] http://www.mortgagenewsdaily.com/mortgage_rates/blog/182537.aspx

  3. I don’t think that many politicians understand monetary policy enough to get them involved in “auditing” the Fed. I believe that if the Fed were required to answer questions about policy during hard economic times, it would become a way for politicians to place blame on the Fed. This would put the Fed in the middle of political battles it has no business being in.

    The other problem is that forcing the Fed to constantly explain itself could possibly harm its ability to conduct policy. Much of the power the Fed has only reaches as far as its ability to affect expectations. If the Fed were to be politically attacked or second guessed by politicians, it may be unable to effectively change expectations. It could also be the case that if politicians have too much power over the Fed, the entire economy could be stuck in a stalemate if both Congress and the Fed are unable to conduct policy as a result of political deadlock.

  4. The problem with any dual mandate is eventually the two run in opposition. During good times the Fed has been good at controlling inflation, people don’t believe they will intentionally create inflation to fight unemployment. The steps needed to avoid the worst economic conditions, deflation spiral, are extremely unpopular and COULD NOT be done with our current do-nothing partisan bickering in Washington and hence could only be enacted by an independent authority. While the Fed is a good punching bag for nimrods in congress the truth 1 is I wouldn’t trust the average congressman to dog sit much less decide monetary policy. Additionally if you think the Fed is slow to act wait until congress gets involved. They only work 2 days a week and many times there is not even a quorum in town! Giving this power to congress would just create another bureaucracy, this one that answers to and is influenced by congress instead of no one. Stripping the Fed of its dual mandate would create instability in the economy because it changes the framework that companies and investors are used too at the same time it puts that power in the hands of temporary elected officials that are already trading on insider information, how much worse would this problem be with access to monetary policy as well 2?. I believe Iceland’s success can be attributed to NOT changing expectations. While bailouts are now expected in most of the Western world, Iceland stuck to the old rules. Now, they have don’t have the massive bank losses sinking governments (Ireland) and are free to conduct their new monetary policy with extreme credibility.
    1) http://www.ronpaul.com/legislation/audit-the-federal-reserve-hr-1207/
    2) http://insidertrading.procon.org/

  5. Recently the Fed has come under fire for lending out an estimated $9 trillion in overnight loans to financial institutions and corporations in the US and around the world. However all of these loans were approved at the discount window supported by collateral and at a interest rate ranging from .5% to 3.5% annualized rate. In addition all of the closed loans have been paid back in full. If the central bank had been under congressional oversight a major loans program at a quickly reduced discount rate would not have passed resulting in a sudden lack of liquidity in the market resulting which would lead to a worse recession than what we are facing right now. Requiring the fed to gain congressional oversight to make policy changes would result in the public becoming aware of the weakness of the financial institutions possibly resulting in a run on the banks. (1)
    In addition keeping the Federal Reserve separate from the review of congress keeps the institution free of the political swings. By remaining independent of congress the fed does remain more mysterious, but it also becomes more credible since investors are won’t expect its policies to change every two years with the new incoming representatives. By being more credible the Fed becomes more able dictate the movements of the market as whole aided the US economy in its aims to maintain a low, stable rate of inflation and maintain a low rate of unemployment.

    (1)http://money.cnn.com/2010/12/01/news/economy/fed_reserve_data_release/index.htm?iid=MPM

  6. I don’t believe that the Fed is in any danger of having to cede to these outcries. To me this argument is less grounded in logic and more so in politics. With the recent swing in momentum for the conservatives and especially the Tea Party, disempowering the fed would simply be another victory. Regardless of the fact that Obama will block any effort to follow through on these actions, once these ideas become mainstream the power of logic will prevail. As economist Greg Mankiw says “That is, with inflation now below its target, the Fed could be pursuing QE2 even if it were operating under the proposed mono mandate” [1]. The rules-based inflation targeting regime would tell the central bankers to increase the money supply in order to reach the target. Just as the conservatives are questioning the qualifications of a Nobel laureate [2], stripping the Fed of the dual-mandate is not for the greater good but rather for the political agenda. The Fed is ‘independent’ for a reason, it is meant to maintain price stability and promote employment for all people.

    I do believe that the Fed should follow more rules based policy, but such a drastic shock as proposed by the Conservatives could cause major instability. The move to a rules-based regime could be a good median as the central bankers would become operators of a system, not making decisions. Yes, the Fed may need to reevaluate some things, but simply making changes to make changes is irresponsible and potentially devastating.

    1. http://tinyurl.com/28bx2df
    2. http://tinyurl.com/3x5pl2d

  7. The Federal Reserve is in no way shape or form disappearing, in my personal opinion it will still be a fully functioning body for the entirety of my generation and beyond. With that being said an extreme change in the way the Fed operates or perhaps a removal of select powers it holds is certainly not out of the question. The biggest issue that most have with the Fed is that it has tremendous power, but its members are not in any way elected officials. The Fed currently acts with a duel mandate to have long run sustained low and steady inflation coupled with a full employment level of output. Obviously this task is becoming increasing difficult, but now more than ever the Fed’s actions are being felt by Main Street America. As the crisis and its effects are clearly still lingering, what has the Fed done has not truly been disclosed in its entirety. Many are now calling for an audit of the Fed, which I believe is absolutely in order. This issue, perhaps more political than economical, is one that should be addressed with a checks and balances mindset. The Fed loaned out some two trillion dollars during the financial crisis and at the time it was decided that not disclosing specific details of who was receiving funds saved face for the institutions doing the borrowing. Now, we would not have much way of knowing the potential scandal that may have taken place with these funds on either the Fed’s side or the firm side. On Tuesday, May 11 the Senate unanimously approved the Fed’s audit and I am interested to hear the final results. Until then it remains to be seen what further action should be.

    http://www.marketwatch.com/story/senate-unanimously-approves-measure-to-audit-fed-2010-05-11

  8. Maintaining an independent central bank is crucial to the future of the country. With checks and balances, unclear motives, and painfully partisan behavior crippling Washington’s ability to act on behalf of the country, an independent entity is a necessity. When the central bank makes a decision regarding policy change, they take action to enact that policy immediately, whereas fiscal policy changes, being handled by the government, can takes months or even years to enact. Incorporating the central bank into the government would also increase the political motives that we have seen to often be short-sighted and harmful to the health of the country.
    I don’t think that the Central Bank should have to explain all of its policies and maneuvers to the public. Like Richard said, much of the Central Bank’s ability to affect the economy comes from manipulating future expectations. When the country is in, or close to, a liquidity trap, altering expectations is the only thing that monetary policy can do in order to help the economy. I also don’t think, after watching several of the congressional depositions on Wall Street, that politicians know enough about monetary policy to control it, and therefore, think that the central bank should be run by academics.

  9. Do you believe that pressure on central bank independence will alleviate if and when economic conditions improve? Or do you believe that the central bankers will take much of the blame for the build up and collapse in the recent recession.

    I believe that recent criticism of the Fed is largely due to the current economic conditions the US is facing. If the economy was not facing high unemployment among many other issues, people would not be concerned with the Fed’s policies. I don’t think the Fed can be blamed for the build up and collapse of this recent recession — I think they’re only option was to use they policies they did and that QE1 and QE2 were the right decisions. As others have said politicians should not be trusted to make the decisions the Fed makes…they have too many self-interests. I don’t think the central bank is in danger of disappearing, though possibly being monitored more closely.

  10. I think that the new wave of criticisms attacking the central bank and its independence are primarily a result of the economic and financial problems that the U.S. has faced lately. It seems like congressmen are attempting to politicize the problems that we are facing. I think an independent central bank is a good idea, and that too much transparency would destroy the effectiveness of our monetary policy. That being said, I think that a two year lag releasing information would be a positive change because it would increase transparency, but not take away effectiveness. I don’t know what type of system is preferable to those who support the abolition of the Fed. Are they suggesting that maybe Congress run monetary policy? Or the President? If you suggest that we eliminate the current system and the Fed I think you should have a fundamentally sound alternative. I agree that our current system has many flaws, but there doesn’t appear to an advantage to eliminating the independence of the Fed. Economists should have a long-term perspective, they shouldn’t have to worry about upcoming elections or harsh criticism about every decision they make. If there were greater transparency then the criticism would never end. There is a loser to all the decisions that the Fed makes, whether it be lower or raising interest rates. They are tasked with making objective decisions in order to fulfill their mandate.

    http://www.bloomberg.com/news/2010-11-03/bernanke-faces-more-congressional-scrutiny-after-republican-election-gains.html

  11. I feel like “auditing the Fed” and making them become 100% transparent, through means such as instituting live meetings, would have a negative impact by providing a disincentive for the most qualified people to become central bankers. This is because of the conflict of interest between central bankers and investors. The job of a central banker is to lower inflation by raising interest rates. However, raising interest rates is bad for people who want to borrow or invest. If decision makers were put under the light and intensely scrutinized, they would be more willing to choose a policy that is in the interest of investors that is not aligned with the purpose of the central bank. I believe taking away the “dual mandate” would create a more stable economy because inflation targeting would achieve the desired goals central bankers are meant to accomplish while often for whatever reason they do not make these decisions. By implementing this policy, it takes away the possibility for a central banker to make an adverse decision. Additionally, I do not expect these pressures to alleviate due to how severe this recession was. It should leave a bad taste in the mouth of the general public and lead to maintain transparency and perhaps undue blame for the recent crisis on the central bankers of the time.

  12. When it comes to the decision on whether or not the Fed should have to explain their monetary policy actions (essentially auditing them), I feel that this is not how things should be handled. By auditing the Fed, the government could cast doubt into the minds of many Americans and ultimately dissolve some of the Fed’s credibility and power to manipulate our economy in helpful ways. If auditing them does indeed turn out to be the final decision, the results should be kept private between a select number of people and shouldn’t be openly announced to the public for the same reasons I listed before. Eventually I think that the current criticism and pressure being forced onto the Fed will dissipate once economic conditions are back on the rise. Right now, because our economy is having problems politicians always need someone to blame for problems and someone to “punish”. In this case however, stripping the Fed of some of its powers is not the correct answer and politicians should carefully consider the implications of the things they are suggesting.

  13. If someone surveyed a cross section of the population during 2005-2006 and asked them “who is the Federal Reserve and what is there job” I am fairly certain less than 60% of the sample would have a solid understanding of the Fed. The only time the Fed is really needed, at least in the public eye, is to save the economy when we are in trouble. Average Americans do not understand that the Fed’s goal is price control and a full employment level of output. Given the fact that economy went through one of the worst recessions in American history and nearly 10% of Americans remain unemployed will now turn more attention to the Fed. All eyes will be on Ben Bernanke and his team, and almost everyone will refer to them as the enemy or as a hero depending on the individual’s level of economic awareness and education. The sophisticated will refer to them as a hero. The unsophisticated will refer to them as an enemy. And the average will lean to whatever side their local newspaper or favorite news station supports.

    If the Obama Administration were to remove the Fed’s dual mandate, who would take over? The answer is politicians, and that is the last thing this country needs. We can’t have people without economic backgrounds controlling the most complex, advanced, and innovative economy in the world. Their policy efforts will be dictated by pure criteria such that if GDP is negative lower interest rates 25 bps, leaving now actual interpretation for the broader view of the economy. All the members of the Fed are PhDs and successful practioners for a reason, unlike their diplomatic counterparts whose sole purpose is to get reelected for multiple terms and have no advanced background in business, economics or banking.

  14. I agree with Justin’s comment on the average US citizen’s level of economic education, or lack thereof. Additionally, high unemployment rates and foreclosure rates, coupled with politicians’ efforts to make a spectacle of these numbers, definitely seems to be fueling a lot of Fed bashing.

    That said, I don’t think that stripping the Fed of its mandate to maintain “maximum employment” would politicize the Fed. While I do not think this is necessary, as the Federal Reserve will only, or rather should only, combat cyclical unemployment, I feel like it would reduce political pressures to implement policy to achieve political ends.

    If any changes should be made, I think the Fed should be stripped of its “unusual and exigent” clause. It was known before the more recent press releases that the Fed was essentially just lending to money market funds and other institutional investors that purchase large amounts of commerical paper in hopes of keeping these markets fluid; what part of the mandate covers that policy tool? Also, I am just unsure how I feel about these Fed orchestrated buyouts (LTCM, Bear, WaMu, CountryWide, AIG, Merril Lynch, to name a few more recent ones).

    But, while I think the Fed could be reformed without longterm adverse consequences, it isn’t really that big of a problem compared to other issues facing our nation/economy (do we separate the two these days?). I don’t worry too much about deflation nor excessive inflation, as I think the Fed can create as much inflation as it wants, and IEORs, along with other traditional policy tools, can quickly suck up reserves.

    I think there is a lot of uncertainty over fiscal policy. We cannot grow out of this debt. Taxes will be going up, and my bet is on real Fed debt monetization in the not too distant future. Many states are facing serious fiscal issues; also, many states’ pension funds for their workers are underfunded, or soon will be. On top of this, we need dire investments in our nations bridges, roads, and levies (http://apps.asce.org/reportcard/2005/index2005.cfm). The Corps of Engineers issues a report every five years or so, and our avg. grade is a D). Politicians seem to be too myopic to deal with any of these issues.

    But, I have no real suggestions for how to fix any of this. I hate politics.

  15. Justin makes a valid point that many citizens in times of economic turmoil tend to blame the central bank for the recession. But the fact is that money is endogenous, and the role of CB causing the recession was limited. Obama’s continued faith in Bernanke seems to be a positive outlook for Fed not dissolving [1]. By making the CB transparent, it completely limits Bernanke’s ability to help American exports become more appealing to foreign consumers. Obama wants to have an export led growth in the next couple of years[2]. The major problem with this is that all export buying countries like Japan and Europe are experiencing debt. If Obama’s political plan is to promote export led growth and fight debt he will need the Fed to do so.

    By stripping the dual mandate from the Fed it weakens the U.S. ability to fight the growing currency war between Europe, China, and Japan. Republican’s goal in congress should supporting Obama, promoting growth and establishing a stronger foreign trade policy regarding China. The reason for this is that China artificially manipulates its currency. Since China’s currency is pegged it is destroying the U.S. ability to get out of economic turmoil [3].

    [1]http://www.bloomberg.com/news/2010-11-20/obama-prepares-new-overtures-to-business-to-keep-agenda-moving.html
    [2] http://online.wsj.com/article/SB10001424052748704323704575462060281977870.html
    [3] http://abcnews.go.com/Business/wireStory?id=12208875

  16. @Brad

    I think you have some valid points about the Fed being reformed, but the current economy is not just tied to the U.S. but in fact it is globally. I think the Fed plays a crucial role helping Obama get the economy out of the recession. If the Politicians and the Fed can agree to attack the currency war through economic and political actions, the whole world economy would be better off.

  17. The key advantages to having an independent central bank are that you can have central bankers more inflation averse than median voters, as well as insulation from political business cycles that would be volatile during elections. While it is also felt that politically motivated central bankers would be more inclined to maximize output and minimize employment, politics does not belong in economics. The two have and will always overlap, but the complexities of a massive, moving, national economy like the United States are far too intricate for Congress to fully understand. Central bankers have highly specialized education that politicians lack. Rand Paul’s belief that, ‘It wasn’t that the homebuilder was stupid, or the mortgage broker was stupid,” illustrates the main problem, that involving politics means lack of understanding paired with political grandstanding. [1]. Therefore it is unlikely audits would do anything more than create another arena in which Democrats and Republics can stage a public political struggle, which would do very little to assuage the concerns of investors, or promote stability.

    Obama’s recent attempts to “address corporate criticism” will also hopefully reduce festering bailout resentment, possibly to the Fed’s advantage. [2] Rand Paul also demonstrates that in a crisis no one feels better unless there is a scapegoat, so politicians have turned to the Fed as theirs, once this crisis is navigated pressure on the independence of central banks will wane. The dual mandate of the Fed gives the central bank room to make educated decisions about how best to steer the economy, stripping it means giving them less avenues through which to work, thus limiting the scope of possible solutions to problems. Rule based monetary policy runs the risk of oversimplifying and cornering the Fed to the detriment of the economy’s well being. Central bank independence has been threatened by this most recent recession especially, however, ideally the educated population will remember that unexplored alternatives could have more severe repercussions and taking drastic steps against the status quo does not guarantee a more beneficial outcome in the future.

    1. http://www.bloomberg.com/news/2010-11-03/bernanke-faces-more-congressional-scrutiny-after-republican-election-gains.html
    2. http://www.bloomberg.com/news/2010-11-20/obama-prepares-new-overtures-to-business-to-keep-agenda-moving.html

  18. I realize I am posting late, and perhaps few will actually read this, but I feel a need to respond to many of the early comments. I was going to mention people and my objections to their posts specifically, but as I read through the comments I realized most people seemed to be looking at the issue the same way. I do not.
    Firstly, I would like to simply point out a few glaring (in my opinion) philosophical flaws in many of the arguments put forth. People insist that the ordinary person is not qualified to understand the workings of the financial system. Perhaps so. The consensus then espouses an autocratic fourth branch of the government to run the system for all those common people, who are too stupid to decide for themselves. This branch is to be completely independent, able to do things against the desires or market forces of the economy, with effectively no limits. They should be accountable to no one, because Big Brother Economist knows best.
    Has anyone been paying attention in class? We have studied one theory after another which were hailed as tremendous breakthroughs, used to advise the running of the economy, and then discovered to be flawed. Then a new theory is formed, or an old one revised, and it takes the place of the first as the newly discovered right way. The only theories we have studied so far that have not been found to either have gaping holes of unrealistic assumptions are the most vague ones, which are difficult to disprove since they have so many explanations, and the most recent ones, which have not yet faced the test of time that has brought down their predecessors. This is not to discredit economics, much has certainly been learned, and elements of truth have been present throughout. However, the notion that this year’s economists really do have everything right this time, and that despite the track record of the field, we can now sort through all the false assumptions and generalities to know the exact right thing to be done seems unwise at best.
    I support as much openness as possible. I do understand that there are many problems with that, according to current theories. But particularly when I see arguments that things cannot be open or accountable because a) significant aspects of the bank’s effectiveness rely on deceiving the public, and b) people would get made because many of the central bank’s policies are hurtful to them, I have major doubts. The entire concept of a free market is predicated on the concept of open exchange controlled by market forces with as much equality of information as possible. The entire concept of democracy is likewise predicated on the concept that people can learn to govern themselves. These theories may be proven wrong by history, but I’m not quite ready to discard them.

  19. To continue, though I may be past the time limit on this post, I do not feel that the Federal Reserve is likely to open up much in the near future. It is fundamentally a government bureaucracy, despite earlier comments to the contrary, and such organisms excel at self perpetuation. It is supported by a plurality of economic experts, and the concept of a board of elites meeting behind closed doors to run the country, fits in perfectly with several mainstream political philosophies. The idea that they are the experts who know best, and the common people should just shut up and work as the central bank manipulates, since the non-elites do not know what’s good for them, seems likely to ultimately be as disastrous in the economic realm now, as when the same idea has been taken much farther, for example in the soviet union. Managed economies generally fail, and the more government “help” businesses have to work around, generally the more problems arise. While some regulation is needed to prevent abuses, I feel that the very existence of the Federal Reserve should be considered open for debate. Certainly the idea of granting them the myriad powers they have recently assumed, while demanding even less in the way of accountability seems philosophically repugnant. Let banks fail, let a debt based economy collapse, if it cannot sustain its own weight. This is the nature of progress. Government intervention creates artificial distortions, which the natural market forces attempt to right. Observe Fannie and Freddie, or the effects of our effective tax subsidy for debt based business plans over capital plans. I believe the economy should be as laissez faire as possible, excepting only what regulation is needed to prevent blatant fraud or human rights abuse. At the least, the fed should be transparent.

  20. The Fed cannot perform such a fundamental political function and it will remain insulated from politics. Only repeal of the dual mandate can rescue the Fed from the bad economic conditions eventually to its independence which they have responsibility of role as the savior of the economy. Many politicians does not believe what fed do right now which made US economy worse than before. Only way to control the inflation and unemployment, I think Politician have to audit Fed and also they have to take control of CB too. So Fed and CB suppose to know what they are doing.
    I do not blame recent recession to CB. Their responsibility is control of intrest rate to change inflation rate and I don’t think changing of intrest rate make recent recession. I think major cause of recent recession are Fed use wrong monetary policy and CB also followed what fed did. If CB got independence then interest rate will not be stable and investor will not invest money which make another recession.

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