Can the Fed stay independent?
WASHINGTON -- It's unclear whether one or both, or neither, of President Trump's selections for the Federal Reserve Board -- Stephen Moore and Herman Cain -- will win Senate confirmation. What is clear is that this is a teachable moment concerning the Fed's vaunted "independence."
If you think it means that the Fed can do whatever it wants and is truly independent in law and deed, then you are woefully misinformed. But if you think the Fed is simply a political lackey of the president or Congress, then you are also misinformed.
The defining traits of the Fed's "independence" are its ambiguity and flexibility. It is an elastic concept, meaning different things at different times for different reasons. The Fed's basic tools are its ability to set short-term interest rates (the so-called fed funds rate on overnight loans) and to influence long-term interest rates (mortgages, government bonds).
These and other powers were delegated to the Fed for two reasons.
First, monetary policy -- altering interest rates and credit conditions -- is highly technical. Most members of Congress don't have the time or the temperament to immerse themselves in the murky details.
Second, and more important, these decisions are often highly unpopular. Sometimes raising short-term rates is the right thing to do for the long-run -- containing inflation or financial speculation -- even if the immediate effects are unpleasant. Presidents and Congress wish to insulate themselves from a public backlash by deflecting criticism to the Fed.
As Sarah Binder and Mark Spindel observe in their recent book, "The Myth of Independence -- How Congress Governs the Federal Reserve":
"Congress depends on the Fed both to steer the economy and absorb public blame when the economy falters. ... [B]y centralizing power in the hands of the Fed, lawmakers can more credibly blame the Fed for poor economic outcomes, insulating themselves electorally and potentially diluting public anger at Congress."
Sometimes, the White House and Treasury's mastery of the Fed has been almost absolute. Consider World War II. The Fed kept interest rates artificially low to finance defense spending (rates were 2.5% on long-term debt, less than 1% on one-year bonds and less than 0.5% on 90-day bills).
"The war brought [the Fed] squarely under presidential control," writes Peter Conti-Brown in "The Power and Independence of the Federal Reserve."