ECON430-Topic #4: Fed Independence

There has been a lot of debate about Federal Reserve independence lately as members of Congress contemplate stripping the Fed of some of their authority. In addition, the Treasury is under fire for its handling of the crisis and the subsequent bailouts. The proposals put forth by Ron Paul and supported by several other members of Congress would essentially “audit” the Fed, requiring the central bank to reveal many of their actions during the financial crisis. Treasury secretary Timothy Geithner was under attack by Kevin Brady (R-TX) a House Republican who told him, ‘The public has lost all confidence in your ability to do the job.’ Geithner replied, ‘What I can’t take responsibility is for the legacy of crises you’ve bequeathed this country.’ The Fed’s Bullard recently commented that Fed independence is crucial to price stability. However, the issue of transparency might be threatening the very independence the Fed desires (or maybe requires).

Now, in spite of all the bickering between the Congress, Treasury, and Federal Reserve, there are serious issues regarding the future powers of these institutions. The Federal Reserve and Treasury have been lobbying for the power to be the systemic risk manager, which would add additional oversight powers to whatever institution these rights are granted to.

Questions you might try to answer:

  • Do you believe that Fed independence is fundamental to their mission? What evidence can you provide?
  • How has the lack of transparency impacted the belief that the Fed and Treasury are acting in the best interest of the country? 
  • What is the primary alternative to using the Federal Reserve to control interest rates and the Treasury being allowed to run deficits?

I would like your statements to be as subjective as possible, or in jargon terms, positive and not normative in nature. Also, remember, I want you to keep your descriptions short, basic, and related to classroom content. Read other students comments before posting, and please leave your name with your posting.

11 thoughts on “ECON430-Topic #4: Fed Independence”

  1. The Fed's independence is important to the running of the fed for several reasons. there are the issues of transparency and confidentiality, the Fed's banking regulation functions, and the Fed's policies being politicized, which cannot be maintained if there is no independence.one of the Fed's tasks is to be a lender of last resort. as an independent body, they are able to lend to parties without having their confidentiality compromised. with lack of independence, there might be an issue. there will no longer be confidentiality because the issue will be dealt with by a group selected by congress that has to expose all matters to the public, and this might throw the parties working with the Fed off.the issue of politicization of the Fed may also become real because the 1978 provision which prevents the politicization of the monetary policies will be compromised.politicians will tend to make decisions that are based on their careers and not the good of the nation and Fed's operation as a whole. i honestly believe that leaving the Fed as an independent body is beneficial to their mission. however, as an economics student, i don't believe that they should be let to make decisions without being held accountable. this is an issue that many of the congress men fighting to revoke the Fed's independence are dealing with. i believe that independence and accountability are two different issues that can be done simultaneously by the Fed.http://www.ritholtz.com/blog/2009/11/bernanke-defends-the-feds-independence/http://www.heritage.org/Research/Economy/bg2342.cfmhttp://www.econbrowser.com/archives/2009/07/concerns_about_1.htmlhttp://economistsview.typepad.com/economistsview/monetary_policy/

  2. The independence of the Federal Reserve is a cancer that will continue to reak havoc on our economy until we bring about change. The Fed which was formed in 1913, has at least been partly responsible for every economic downturn in the last century. In fact, the single greatest depression in American history started only 16 years after the Fed was started. This depression was of course the "Great Depression" and was started by failing on Wall Street, which is what we are going through again now. The Fed creates artificial "booms" in our economy by creating money that is not even backed by a gold standard, and by setting the interest rate. The Fed's independence is what is keeping politicians from wanting the best for their nation. The Fed can artificially create a boom or recession near an election to put the favor in the hands of one candidate. In order to get rid of artificial policies that only lead to chronic recession, we must get rid of the Fed's independence.-Ryan Oliverhttp://www.bloomberg.com/apps/news?pid=newsarchive&sid=ai2ut4aGjK1Yhttp://www.independentpoliticalreport.com/2009/01/wayne-root-destroy-the-fed-before-the-fed-destroys-us/

  3. I agree with Mayfredrick that Fed independence is fundamental to their mission. Historic examples of Bolivia, Argentina, and Mexico, (countries experiencing high government budget deficits and high levels of inflation), successfully stabilized inflation by combining “fiscal adjustment with credibility-enhancing policies through outward commitments to fixed exchange rates and increasing the independence of central banks” (Rogers, Wang). While Rogers & Wang’s work does not provide answers that address our current financial turmoil, it does indicate certain scenarios in which an independent central bank is favored over a non-independent one. It is my opinion that the legislation proposed by the Senate Banking Committee to strip the Fed of its role of supervising big banks, and Ron Paul’s proposal to expand audits of the Fed including interest rate decisions would drastically reduce the Fed’s credibility while simultaneously removing the tools needed by the Fed to make their operations work. Furthermore, as Reddy & Paletta reiterate, the Fed does not identify which banks it lends directly to for a fear of sparking a run on that bank. The lack of transparency in the Fed’s actions has set-up the perfect circumstances for the Fed to be the scapegoat of our current financial crisis. What has been less talked about is the fact that one of the greatest recessions over the past several decades did not turn into a depression due to the actions taken by the Fed and the Treasury. The primary alternative to the Fed and the Treasury appears to be the Fed and Treasury acting on behalf of political parties. In my opinion this would cause the Fed to act more like a hybrid between a central bank and a private clearinghouse, a Fed that is entirely too biased reflected by its political motivations.Rogers, John H., Wang, Ping. “High Inflation: Causes and Consequences”http://www.dallasfed.org/research/er/1993/er9304c.pdf

  4. I think it is absolutely necessary to let the Fed remain independent. If their power of independence is stripped from them, then increased political pressure will lead to an ineffective Fed. Politicians will try to persuade the chairman and governors to use expansionary monetary policy in order to lower unemployment in the short run. However this produces higher inflation and higher interest rates without lowering unemployment in the long term. Politicians aren't thinking about the long term, they only want to be re-elected in the short term. Since this is generally the case, an independent Fed will be more likely to resist the temptation to monetize the debt. Politicans signed off and voted on bills to spend enormous amounts of money, and if they are having any regrets about it, they are less willing to raise taxes. Printing new money would be a much easier decision for the members of Congress than the Fed board of governors. If their independence is stripped, inflation is more likely to be an issue in the future. It is unfortunate that the Fed is being attacked for this crisis. If the Fed is forced to show all their records of the banks that come to them in privacy, this would have a negative effect on their power. The American public will lose all faith and confidence in those banks.

  5. I believe that the Fed independence is fundamental to their mission. According to what we have learned during the past lectures, politicians often use the monetary tools for their re-elections, causing higher average inflation rate. The Fed should act for the sake of the U.S. economy, not to keep congressmen’s jobs.The primary alternative to watch the Fed and the Treasury is to create another agency that has a power to audit the Fed and the Treasury or we can have more restrictions. The Fed’s transparent policies will affect the investors to have more credibility on the government’s policies, and may encourage the market.

  6. I also agree that in order for the Federal Reserve to effectively carry out their duties, remaining independent from the influence of politics is imperative. May made a great point that since the chief duty of the Fed is, “conducting the nation's monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates,” political manipulation would only be deleterious because of the inflationary bias it would create. This would occur when politicians are up for re-election; in order for the politician to gain a political edge they would force the Fed to slash interest rates, this would cause consumer spending to increase, however, the new output level the politician is trying to reach is unattainable because firms are not willing to supply the necessary output at the initial level of inflation. The excess demand raises inflation to a level where firms are willing to increase their supply to meet consumer demand. At this point in the IS/PC/MR model, the SRPC would shift outward to incorporate the new level of inflation. This adjustment brings what firms are willing to supply back to the original level of output but at the new higher level of inflation. Since we still have excess demand, inflation rises once again. As long as the politician pressures the Fed to keep the real interest rate low, inflation will continue to increase as the economy tries to reach an unattainable level of output. -Alexhttp://www.federalreserve.gov/aboutthefed/mission.htmKeith Bain,Peter Howells, Monetary Economics 2nd Edition 2009

  7. Fed independence is fundamental to their mission. If Fed is under government control, controlling inflation will be harder because of the fear of monetization. Our politicians just don’t have will power or discipline to run responsible fiscal policy. And value of dollar in exchange market will plummet, leading to inflation. Also every election season economic activities will halt because of increase in uncertainly. Also Fed and treasury should not be transparent, because sometimes Fed’s action might be politically unpopular. However, not every popular policy is beneficial to the economy. A policy might be harmful but important and vital to our economy. If Fed cannot and control interest rate and the treasury cannot run deficit, we cannot use monetary and fiscal policies to get us out of the recession. Then only option is to wait for the economy to adjust itself. However, this is very painful and dangerous process because the economy could fall into deflationary spiral.Sanghun Kimhttp://www.bloomberg.com/apps/news?pid=newsarchive&sid=aqUfLCJcZ7Owhttp://krugman.blogs.nytimes.com/2009/07/15/deficits-saved-the-world/?scp=3&sq=monetization%20national%20debt&st=cse

  8. I agree with the idea of Fed being independent. An independent Fed can help improve the country's economic situation, maintain price stability and check unemployment levels, by acting promptly whenever the markets demand, and not when the Senate orders. An independent Fed can smooth monetary policy by its control over the country's monetary policy, and the Fed can literally design the course that the country will take for a long time to come. Because it does not have to ask the Senate for every little move it makes, the Fed can instantly make open market operations whenever the economy demands without wasting time. Also, with its independency, the Fed can easily avert crises in the financial markets, and on a day to day basis compared to the government which takes a long time to make its decisions. Also, as learned from the class, if the Fed was not independent, it could be used in the hands of a President hoping to be re-elected by simply increasing the money supply a few months before the election and take all the credit for the booming economy. As it is used for the politicians' short-term needs, unemployment also could fall for a short duration, but inflation would come along with the unemployment in the future. Also, a dependent Fed might end up as the legislator's personal bank. The government might order the Fed to print more money to provide for the government's lavish expenditures. Due to these reasons, the Fed should be independent. -Nak ChoiFox, Justin. "Did he blow it?" Fortune. New York: Apr 2001: 26.

  9. I think, like the rest of my fellow classmates, that the Fed independence is fundamental to their mission. From what we have learned about in class, and from reading these articles, having politicians in control of the Fed is a dangerous thing from an economic standpoint. One of the main concerns of this is looking at the possible inflation that will ensue if the Fed were to loose their independence. Political officers want to have output as high as possible right before an election, which is why it would be so dangerous to link them and the Fed together. Also Fed independence is essential from a credibility stand point. The Fed has set standards and targets that the country has grown accustomed to. When politicians get involved that credibility is gone, and that credibility is vital to have the complete effect of monetary policy. I don’t think that lack of transparency has impacted the belief of people that the Fed and Treasury are acting in the best interest of the country as much as the fact the economy is in a recession and people need someone to blame. When a county goes in a massive recession it is easy to blame someone, and people chose to blame the Fed and the Treasury. Unfortunately the primary alternative to having the Fed and Treasuries do their respective duty, would be to have the government and elected political officials take on the financial situations. As discussed previously this would be bad for our economy with the up and down shocks that would happen there after.

  10. It is difficult to say whether or not Fed independence is fundamental for economic prosperity. To my knowledge, there has not been a time where the Fed has not been fully or partially independent. If the Fed is stripped of its independence and is subject to regular audits by other government sectors, the outcome is not certain. Since the United States has not experienced this before the effects of this alteration are surrounded by uncertainty. There are a few things however, that are certain. It is certain that the Fed and the chairman of the Fed are being partially blamed for the recent crisis in the United States. Numerous political figures are questioning Ben Bernanke’s ability to perform his responsibility as chairman and point out his lack of efforts and mistakes throughout his term. One politician held Bernanke responsible for the recent crisis; he stated that Bernanke was making the same mistakes that previous chairman Greenspan had made during his term. He pointed out that Bernanke kept interest rates lower than they should have for an extended period of time. These low interest rates allowed for the acquisition of easy money and inflated the housing market bubble. At the time, there was significant evidence that a price bubble was emerging in our markets and Bernanke for one reason or another decided to ignore them. Bernanke is also being criticized for the bailouts of major financial institutions. By bailing out these institutions Bernanke is setting a horrible example for all other industries, giving them the illusion that some firms are too big to fail. He is described as being the definition of moral hazard and in this situation I agree. Although all the blame cannot be placed on Bernanke, it is important to notice that when firms experience moral hazard, they are likely to make bad decisions. If the transparency of the Fed is critical for economic prosperity, and there is evidence of this, then the Fed should be left alone. In the meantime it is important to consider alterations to the present structure of the Fed, simply because it clearly isn’t operating optimally. By experimenting with different forms of monetary rules, the U.S. government can develop the adequate amount of independence the Fed should have. If the Fed is subject to audits of its financial statements, experts can analyze whether or not their policy is being effective. This information should not be publically available as it could present threats to national security and should only be available to qualified government agents. The Fed along with the heads of financial institutions should be held accountable for their actions. If decision makers make bad decisions they should be held accountable by the authorities. The consequences of such actions need to be clear and available so that everyone knows what to expect, whether it is a fine, jail time or loss of job. It is evident that changes need to be made to the structure of the Fed, although the solution is not clear, the United States has different tools at its disposal to derive the solution that is best for our nation. The solution will take time and effort to find, it is important to know that there will be setbacks along the way. We should expect to learn from these setbacks and use them as a source to find the appropriate role the Fed should have in our economy. -Juan

  11. While I agree with my classmates that the transparency of the Fed is crucial to their effectiveness in the economy, I believe it is also important to understand the counterargument that the Fed needs to be more transparent. Ron Paul has been adamant in insisting the Fed be more transparent with the proposal of an audit of the Fed’s activities. According to Paul, the Fed has not freely disclosed all information regarding the large bailouts that occurred in the past two years. It is therefore understandable that Congress and the general public will be concerned public about where trillions of taxpayer dollars are going. However, I do not believe that full transparency of the Fed is the answer to the problem. As my classmates have argued, the independence of the Fed is crucial for its operation. Engaging in audits of the Fed will politicize the Fed’s way of determining monetary policy, which as we have discussed in class, is not ideal for the economy. Still, I believe that the Fed will need to become more transparent in the coming years as the global economy attempts to recover from the worst recession since the Depression. Crucial to the recovery of our economy is confidence in the Fed and trust in their ways of methods of determining monetary policy. Therefore, while I believe Paul’s proposal for the auditing of the Fed and full transparency is not the solution to the economy’s problems, I do believe he is not completely wrong in his argument that if the public knows more about the Fed and monetary policy, they will be more confident in the recovery of the economy. http://online.wsj.com/article/SB10001424052748704782304574542280971009044.html

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