Giving thanks for independent central banks
“A (central) bank has to be Independent because one cannot really trust the politicians –
they are all a rotten lot and any of them might seek to get out of a hole by printing money.”
— Karl Blessing, President, Deutsche Bundesbank, 1958-69
Last week, at our Thanksgiving dinner table, no one gave thanks for independent central banks. I imagine no one at your dinner table did either. We can all be thankful for that because the topic of independent central banks is more likely a dinner conversation stopper than astarter. Of all our economic institutions, though, we should be most thankful for independent central banks.
Why independence is important
Simply put, a central bank controls a country’s money supply. An independent central bank has the authority to conduct monetary policy without undue interference from politicians and political institutions. The quote at the beginning of this article sums-up why central banks need to be independent from politics although it is a bit of an overstatement to say all politicians are a “rotten lot.”
In their often-quoted article Central Bank Independence and Macroeconomic Performance: Some Comparative Evidence, economists Alberto Alesina and Lawrence H. Summers found unmistakable evidence that inflation is significantly lower in countries with the most independent central banks. Their study compares central bank independence with inflation rates in 16 countries. Over the time period studied (1955-1988), Germany and Switzerland had the lowest average inflation rates of 3.0 and 3.2 per year as well as the highest levels of central bank independence. In contrast, Spain and New Zealand had the highest average inflation rates of 8.5 and 7.6 per year and the lowest levels of central bank independence. The U.S. had the third-lowest average inflation rate of 4.1 percent and the third-highest level of central bank independence.
Independent U.S. Federal Reserve
In the U.S., the Federal Reserve System (the Fed) conducts the nation’s monetary policy largely independent of interference from the President and Congress. According to their FAQs web page, the Fed is an independent government agency because ” … members of the Board of Governors are appointed for staggered 14-year terms and the Board chair is appointed for a four-year term. Elected officials and members of the Administration are not allowed to serve on the Board.” Those 14-year terms are one-and-done terms; once a member has served a 14-year term, they cannot be reappointed. Because they cannot be reappointed, Fed board members are less likely to pander to the whims of politicians. The Fed is also self-supporting because it “does not receive funding through the congressional budgetary process. The Fed’s income comes primarily from the interest on government securities that it has acquired through open market operations.”
Although the Fed operates independently, Congress sets the Fed’s goals, which currently include: (1) promoting maximum employment, stable prices, and moderate long-term interest rates; (2) promoting the stability of the financial system; (3) promoting the safety and soundness of individual financial institutions; (4) providing services to the banking industry; and (5) promoting consumer protection and community development. Ultimately, the Fed is accountable to Congress as “twice a year, the Federal Reserve submits an extensive report on recent economic developments and its plans for monetary policy. In addition, the Chair and other Federal Reserve officials often testify before the Congress.” The Fed is also “audited annually by an independent, outside auditor” as well as by the Government Accountability Office and the Federal Reserve Board’s Office of Inspector General.
Federal Reserve raising rates and President’s Ire
Given the robust growth of U.S. economic output and historically low unemployment rates, the Federal Reserve has been raising interest rates in prudent, measured steps to avoid runaway inflation (see chart). In 2017, the Fed’s Federal Open Market Committee (FOMC) increased interest rates by a quarter of a percentage pointon three occasions (March, June, and December). Similarly, in 2018, they increased rates in March, June, and September. At their latest meeting in November 2018, the Fed’s Federal Open Market Committee (FOMC), decided to neither raise nor lower interest rates but indicated further raises are expected. According to the FOMC’s statement “the Committee expects that further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation.”
Those “further gradual increases” are likely to raise the President’s ire as, in a departure from tradition, President Trump has frequently publicly criticized the decisions of the Federal Reserve. Regarding the President’s criticisms, Larry Summers, who led the Treasury Department under President Bill Clinton and served as President Barack Obama’s top economic adviser, told CNNMoney that “nothing of this kind has happened in the past 25 years.” In April 2018 the President tweeted “Russia and China are playing the Currency Devaluation game as the U.S. keeps raising interest rates. Not acceptable!” Similarly, in a June 2018 tweet the President said “The United States should not be penalized because we are doing so well. Tightening now hurts all that we have done. The U.S. should be allowed to recapture what was lost due to illegal currency manipulation and BAD Trade Deals. Debt coming due & we are raising rates – Really?” In October 2018, after a drop in the stock market President Trump told reporters “Actually it’s a correction that we’ve been waiting for a long time, but I really disagree with what the Fed is doing. I think the Fed has gone crazy.”
The President’s comments reinforce the wisdom of Karl Blessing’s quote and highlight why we should be thankful for our relatively independent Federal Reserve System.