Is the Fed independent? Should it be separate? Has independence been an important topic in the past? Specifically, should new Fed governors be biased toward economic growth, consistent with current fiscal policies over expected inflation, and focus on price stability? The recent discussion associated with new Fed governors is nothing new. The Fed has always fought for as much independence as possible, yet the Fed is a creature of Congress.
Historical Overview of Fed’s Independence
An explanation of the Fed’s creation and relationship with Congress
The Federal Reserve System, aka the Fed, was created by Congress in 1913 in response to a series of financial panics that had occurred in the US in the late 19th and early 20th centuries. The Fed was established to provide a more stable and flexible banking system to respond better to economic crises.
The Fed is a quasi-public institution, meaning that it is a mix of public and private ownership. Its Board of Governors is appointed by the President and confirmed by the Senate, while member banks own 12 regional banks in their districts. The Fed is also subject to oversight by Congress, which can pass laws regulating its activities.
The relationship between the Fed and Congress has often been contentious, with lawmakers sometimes seeking to exert more control over the central bank’s activities. However, the Fed has generally maintained its independence and autonomy in setting monetary policy.
The Humphrey-Hawkins Bill and its Impact on the Fed’s Independence
The Humphrey-Hawkins Full Employment Act, passed by Congress in 1978, was a landmark legislation that significantly impacted the Fed’s independence. The law was seen as a response to the high inflation and unemployment of the 1970s, and its proponents argued that the Fed needed to be more accountable to the public and focus more on employment. Critics, however, argued that the law would limit the Fed’s independence and force it to pursue conflicting objectives.
The impact of the Humphrey-Hawkins Act on the Fed’s independence has been mixed. On the one hand, the law has provided greater transparency and accountability, as the Fed is required to report regularly to Congress on its activities. But on the other hand, the law has also been criticized for politicizing monetary policy and limiting the Fed’s ability to respond to economic crises.
The Fed’s fight for independence over the years
Since its creation, the Fed has fought to maintain its independence and autonomy in setting monetary policy. This has often involved resisting political pressure from lawmakers and the executive branch and defending its decisions against public criticism.
One of the most notable examples of the Fed’s fight for independence was during the inflationary period of the 1970s. President Nixon pressured the Fed to keep interest rates low to boost the economy, but Fed Chairman Arthur Burns resisted this pressure and eventually raised rates to combat inflation.
In recent years, the Fed has come under criticism from some politicians and pundits who argue that its policies are too accommodative or restrictive. However, the Fed has maintained its independence and autonomy in setting monetary policy, despite occasional pressure from outside actors. This independence has been seen as essential for maintaining the stability and credibility of the U.S. financial system.
Current Issues with Fed’s Independence
The current policy discussion is more than just having the President pick Fed governors to follow his policy bidding. It is also deeper than whether the Fed will continue to lean toward growth over inflation fears. This issue is more significant than changing any mix between hawks and doves.
Implications for Financial Markets
We don’t have a bias on what should be done. We are interested in the choices made because of what will happen to financial markets. Our greatest fear is not with any specific policy bias as much as a fear that the Fed will continue to have a history of poor forecasting. The impact of forecasting mistakes will only be amplified when a policy is extreme. A temperate Fed will mute poor forecasting. Caution is reasonable, yet no action can be dangerous. A tempered central bank may be best for markets in an uncertain world of poor prediction. A strong bias coupled with forecast errors only means that the result will be a more extreme market reaction when the errors are revealed.