The Myth of an Independent Federal Reserve

The idea of an “independent” Federal Reserve has always rested on shaky ground. Yes, it is consistently described as an independent organization by the media, and the general confusion over what exactly a central bank does, helps obscure the question. But in reality, this explanation is implausible on its face. Today, the Federal Reserve is tasked with explicitly political objectives (low inflation, low unemployment), and its chair is nominated by the President and confirmed by the Senate for a 4-year-term. Additionally, the Fed has recently been given more authority to help regulate the financial sector, ostensibly one of President Obama’s top priorities, and the Fed’s decision on interest rates has a significant impact on the cost of the government borrowing additional funds.

Nothing about any of that indicates independence. President Obama’s popularity as a President hinges critically on the state of the economy (inflation and unemployment), the Fed assists in implementing one of his key policies, and they even help determine the feasibility of ongoing deficit spending. Clearly, the President has a very strong incentive to be on the same page as the Federal Reserve.

Similarly, the Federal Reserve Chairperson is effectively a politician with a Ph. D. No other single government official, including President Obama himself, has their words scrutinized as much as the Fed Chair does on a regular basis. And like any other politician, they have personal ambition. For the Fed Chair, the presumable goal is to get renominated for another term as Chair. In turn, this gives them a strong incentive to work with the Executive Branch.

We don’t need to assume anything conspiratorial to believe that the Fed is not going to be independent from the rest of the US Government. All we have to assume is that the Fed is led by regular human beings who tend to follow incentives. Everything else follows from there.

But having said that, the notion of an independent Fed still lives on in many areas. The reason for this seems to be that the myth is much more pleasant than reality. History is littered with examples of indebted governments attempting to spend beyond their means by simply printing more paper money. The incentives for them to do so are often too strong to avoid. Unfortunately, the scheme typically ends in hyperinflation and the total decimation of the economy. Thus, just about everyone understands that the government probably shouldn’t be in charge of managing a currency.

However, when that same power to regulate the currency is placed in an organization that is the slightest bit removed from the overall government, as with the Federal Reserve, this arrangement is now acceptable. The Fed has effectively all the same powers that a government would have if it managed its own currency directly. But, because we all pretend the Fed is independent, the current arrangement draws far less criticism.

Which is why it’s deeply important to examine just how independent the Fed truly is. I’ve offered a few a priori reasons to doubt its independence, but you don’t need to take my word for it. Today, we’re recommending two brief new articles from Zero Hedge that help bolster this case.

In the first, Zero Hedge discusses the yesterday’s closed-door meeting between Janet Yellen and President Obama. The move comes in the wake of deeply declining economic forecasts from the Fed itself, and ongoing threats from Chair Janet Yellen that the Fed will still raise interest rates at some point this year. That piece is here:

Obama Reveals What He Will Discuss With Janet Yellen

Then the second reminds us of the tenor of a historical closed-door in the 1960s when the Fed Chair of the time met with President Lyndon Baines Johnson. Apparently, President Johnson had so much contempt for the independence of the Fed that he resorted to physical violence to help successfully convince the Fed to pursue his preferred policies. (And yes, that’s a real story, at least according to the New York Times.) Here’s that link:

This Is What Happens Behind Closed Doors When U.S. Presidents Meet With Fed Chairs

In reality, of course, the purpose of Obama’s meeting was to persuade Yellen to try to delay the crisis beyond the election cycle. And there’s little doubt that she’ll be happy to try. Whether she’ll succeed in the attempt, however, remains to be seen.

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