Amidst the debate over systemic regulation, the independence of U.S. monetary policy is at risk. We urge Congress and the Executive Branch to reaffirm their support for and defend the independence of the Federal Reserve System as a foundation of U.S. economic stability. There are three specific risks that must be contained.
First, central bank independence has been shown to be essential for controlling inflation. Sooner or later, the Fed will have to scale back its current unprecedented monetary accommodation. When the Federal Reserve judges it time to begin tightening monetary conditions, it must be allowed to do so without interference. Second, lender of last resort decisions should not be politicized.
Finally, calls to alter the structure or personnel selection of the Federal Reserve System easily could backfire by raising inflation expectations and borrowing costs and dimming prospects for recovery. The democratic legitimacy of the Federal Reserve System is well established by its legal mandate and by the existing appointments process. Frequent communication with the public and testimony before Congress ensure Fed accountability.
If the Federal Reserve is given new responsibilities every effort must be made to avoid compromising its ability to manage monetary policy as it sees fit.
Allan Metzer declines to sign the petition.
“I wrote them back and said, ‘the Fed has rarely been independent and it strikes me that being independent is very unlikely,’” in the current environment, Meltzer tells Deal Journal.
It isn’t that Meltzer, a political economist at Carnegie Mellon University’s Tepper School of Business, thinks the Fed’s recent role rescuing such financial institutions as Bear Stearns, Fannie Mae and Freddie Mac is sound monetary policy. Rather, he faults the committee of academics that drafted the petition for not coming up with constructive ways to keep the Fed independent in face of the current fiscal and political pressures. “It basically says do the right thing,” he says. “That is not very effective.”
Meltzer says history is replete of instances when the Fed bended to political pressure. In the 1930s, the Fed kept interest rates low to help finance government spending for New Deal programs and, later, World War II. In the 1960s, the Johnston administration pressured the Fed to keep rates low to finance its fiscal spending, causing inflation to accelerate. At other times, the Fed has resisted political pressure, as in the 1920s, when Congress wanted it to lower rates to help struggling, over-leveraged farmers, or in 1980s, when the Fed didn’t lower rates even as unemployment soared.
“Now we have the present Fed, which is not at all independent,” Meltzer says. He thinks the current proposal to make the Fed the top regulator of all financial institutions that pose systemic risk is a “terrible idea.”