Economics, Monetary Policy, Pethokoukis

Should the Fed be part of the US Treasury Department?

Credit: St. Louis Fed

Credit: St. Louis Fed

The Bernanke Fed has undertaken unprecedented monetary moves over the past five years. It didn’t ask permission from anyone. It just did it. The only opinions, officially at least, that Chairman Ben Bernanke had to worry about were the other folks on the Federal Open Market Committee. That’s how it works with an independent central bank.

And in return for independence from political pressure to run the printing presses until they melt, central banks will supposedly provide price stability. And studies suggest that independent banks do just that. In probably the most widely cited study, economist Alberto Alesina and almost Fed-chair Lawrence Summers found that advanced economies with high levels of central bank independence also experienced lower average levels of inflation from 1955-1988. As a 2011 St. Louis Fed study concludes:

In 1913, Congress purposefully created the Federal Reserve as an independent central bank, which created a fundamental tension: how to ensure the Fed remains accountable to the electorate without losing its independence. Over the years, there have been changes in the Fed’s structure to improve its independence, credibility, accountability, and transparency. These changes have led to a better institutional design that makes U.S. policy credible and based on sound economic reasoning, as opposed to politics. In times of financial and economic crisis, there is an understandable tendency to reexamine the structure of the Federal Reserve System. A central bank’s independence, however, is the key tool to ensure a government will not misuse monetary policy for short-term political reasons.

No surprise then, given that we are coming out of a near-depression and horrific financial crisis, that some are questioning the wisdom of Fed independence. Amar Bhidé, professor at Tufts University’s Fletcher School of Law and Diplomacy, is one of them. Bhide, skeptical of the Fed’s ability to meet its dual employment-inflation mandate, suggests a more active role for Congress:

US lawmakers routinely delegate technical issues to experts; but, given the hazards of these experts’ often-unwarranted certitude and insulation from popular opinion, lawmakers wisely retain authority over important decisions. Indeed, the US Constitution gives Congress far-reaching powers, including to declare war and appropriate funds for military campaigns.

Against this background, major changes in Fed policy – such as the decision to purchase trillions of dollars’ worth of securities or push interest rates to zero – could easily be subjected to legislative approval (except in times of emergency). While such a system would reduce the Fed’s independence, it would put the onus of difficult political decisions where it belongs: on the democratically elected members of Congress.

While I think Bhide — a creative economic thinker about whom I’ve written before – is wrong about the potential effectiveness of monetary policy, I wouldn’t dismiss out of hand his thoughts about central bank independence. In reality, the Fed likely does take into account congressional attitudes since, after all, it’s independent only by the good graces of legislators. To what extent has the “end the Fed” stuff in Congress made the Bernanke Fed more passive?

In the outstanding Market Monetarism: Roadmap to Economic Prosperity authors Marcus Nunes and Benjamin Mark Cole offers three reasons in support diminished central bank independence: 1) it’s undemocratic, 2) public organizations need accountability, 3) insularity breeds poor performance. In particular, Nunes and Cole have in mind the Fed’s post-recession performance which they believe has contributed to the anemic US recovery: “Are citizens treated as important constituents at the Federal Reserve Board? … Would [the Fed] have pursued such rigid inflation fighting stances from 2008 onward has public been able to vote them out of office?”

The authors go on to remind of the WWII relationship between the Fed and Treasury where the bank was basically obligated to monetize US debt at a fixed interest rate. They also mention a 1984 idea by Treasury Secretary Donald Regan to place some Fed powers at Treasury and otherwise restrict Fed independence.

Possibility: The lack of transparency and the abundance of discretion in Fed policy leads to calls for less independence. Well, that and the Fed’s key role in the Great Depression and Great Recession and Not-So-Great Recovery. A clear policy rule that took into account growth and inflation, like a nominal spending or GDP level target (particularly if was driven by an NGDP futures market rather than the humans on the FOMC) — might go a long way to ensuring bank independence. Its goals would be clear, understandable, and likely far more achievable.

3 thoughts on “Should the Fed be part of the US Treasury Department?

  1. The Fed has become so important in economic as well as regulatory policy, that I fear that its independence has been compromised. You cannot, in a representative republic, give that much governmental power to an agency without making it much more accountable. And it will continue to attract more political attention. The unsightly campaign for Fed chairmanship is not likely to have been an aberration but rather a sign of more to come.

  2. Excellent blogging…and yes, at some point central bank independence must be re-examined if we become Japan-lite…which seems to be the case…

  3. The better consequence of the dilemma between independence and accountability would be for Congress to repeal the Act that constituted the Fed. It has a long term dismal record that is extremely likely to be made much worse by the distortions it has created in the past give years and the inevitable destabilizing of the world economy that will follow.

    The dilemma goes away by this route, along with the Fed.

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