A leading Federal Reserve official has warned against the imposition of constraints on the central bank’s monetary policy independence by Congress, arguing that new fetters would be economically dangerous.
Stanley Fischer, the vice-chair of the Federal Reserve Board, said that even though high inflation was not an immediate threat, it was still critically important that the central bank retained its discretion to set monetary policy without interference by politicians.
His words come amid a number of Congressional proposals that would clip the central bank’s rate-setting wings, as some politicians attack the crisis-fighting measures the Fed undertook to prop up the economy following the financial crash.
Among the Republican-backed measures are bills that would impose official audits of the Fed’s monetary policy decisions, and which would require the Fed to have regard to mechanical rules in setting interest rates, drawing on the work of the economist John Taylor.
Ted Cruz and Rand Paul, two Republican senators and presidential candidates, both attacked the Fed’s actions during a televised debate last week.
In his speech at the National Economists Club in Washington, Mr Fischer said that accountability to elected officials and the public was “an essential complement to central bank independence”.
He criticised mooted restrictions, however, saying they would “represent a departure from the modern governance structure that has come to characterise the Fed and leading central banks around the world”.
In particular, insisting on a review by the Government Accountability Office and potentially a Congressional hearing every time a monetary policy decision deviated from a simple rate-setting equation would mean the Fed would be “subjected to the very sort of political pressure from which experience suggests central banks should be independent”.
One of the prime motivations for central bank independence was the high inflation of the 1970s and 1980s, which in the US was only conquered at huge economic cost by Paul Volcker, the former Fed chair.
Just because inflation was now too low, rather than too high, it did not mean the justification for independence had evaporated, Mr Fischer argued.
Inflation expectations of the general public remained firmly anchored near the Fed’s 2 per cent objective, even though inflation was presently low, Mr Fischer said.
“The anchoring of these expectations is due in great part, I suspect, to the continued credibility of the Fed’s independence from political interference, along with the adoption of the explicit inflation target of 2 per cent,” he said.
“To put this point clearly, the concern over the effects of political interference in monetary policy remains as valid in practice when inflation is too low as when inflation is too high.”
Mr Fischer also warned against proposals to use the Fed as a source of funds for specific government initiatives. Some in Congress have discussed tapping the Fed for fiscal purposes. There have been proposals for the use of dividends paid by regional Feds to help close a gap in the Highway Trust Fund.
Pressure on the Fed is continuing to simmer away in Congress. Jeb Hensarling, the Republican chair of the House Financial Services Committee, said on Wednesday at a hearing with Janet Yellen, the Fed chair, that the Fed was part of a “shadow regulatory system that is neither transparent nor accountable to the American people”.
Earlier in the week, Senator Richard Shelby, the Republican chair of the Senate Banking Committee, made the case for his own legislative proposals, which would include more frequent reporting to Congress on monetary policy and more detailed explanations of decisions made by the Federal Open Market Committee.
“I believe the Federal Reserve should and must remain independent. However, independence is not contingent upon immunity from vigorous congressional oversight and accountability,” Mr Shelby said.
Mr Fischer acknowledged that the picture for central bank independence is being complicated by the rising prominence of financial stability concerns.
In the US, the Fed does not have free rein to set policies to curb the risk of financial booms and busts, because other regulators and the Treasury Secretary are involved via the Financial Stability Oversight Council.
But Mr Fischer said it was arguably appropriate for politicians to have a say when it came to discussing issues like property booms.
He added: “Issues of financial stability have moved out of the shadows and into the centre of our concerns. The resulting challenges are only beginning to be understood — and they need to be understood and taken seriously if we are to reduce the probability of future financial crises.”
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