Federal Reserve Bank Independence

Federal Reserve Bank Independence

        The Federal Reserve Bank was created in 1913 following the Federal Reserve Act under the Woodrow Wilson administration. The Federal Reserve Bank’s purpose is to serve as a last resort lender to banks in times of financial panic and crisis. The idea of a central bank originates from Alexander Hamilton, a founding father, who advocated that the United States should have a central bank that was privately owned. The Federal Reserve Bank is considered an independent entity because its monetary policy decisions do not need to be approved by the President or other branches of government. The key objectives of the Federal Reserve Banks are: maximizing employment, stabilizing prices, and moderating long-term interest rates. Today, there is much debate as to whether the Federal Reserve should maintain its independence. The Federal Reserve Bank never be fully independent of the government due to its close ties to the Treasury and Congress, and thus should not remain independent.

        Independence is essential for the Federal Reserve to make monetary policy decisions that are not influenced by politics. Political independence is one of the main arguments of supporters for the Federal Reserve Bank’s independence. Since the Federal Reserve does not have to answer to the President, Congress, and other branches of government, they are able to make monetary policy decisions based on what they believe is best for the economy. “Political influence, outside the context of deficit accommodation, can also be exerted on the Fed in order to boost reelection chances or to provide accommodation for specific fiscal policy initiatives” (Boettke et al., 2013). If the Federal Reserve were not independent, it would become susceptible to politicians trying to influence monetary policy decisions for political expediency and self-serving, short term results. For example, policies that reduce the unemployment rate for a short-term period could be implemented in order for a politician, such as the President, to use in their favor during the reelection campaign. Although this example is an oversimplification of potential impact of political influence on the economy, it demonstrates that politics can have harmful and deceitful effects on the economy. Thus, having the Federal Reserve Bank independent prevents politically influenced decisions from occurring in regard to monetary policy.

        However, the Federal Reserve Bank’s status as independent of the government is questionable due to its close relationship with the Treasury. Throughout history, the Federal Reserve bank has maintained close ties to the Treasury. During World War II, “the Federal Reserve relinquished control over monetary policy to the U.S. Treasury when it agreed to peg yields on Treasury securities during the war” (Humpage, 2014). This fact shows that historically the Treasury, which is a government controlled entity, and the Federal Reserve Bank have not remained independent. Furthermore, The Federal Reserve Bank cannot operate independently of the Treasury and can even be viewed as the Treasury’s bank. For example, every Monday morning the Federal Reserve and the Treasury communicate information to each other about projections on bank reserves and taxes. As a result, both the Federal Reserve Bank and the Treasury coordinate their actions. If not, the Federal Reserve Bank risks off-setting money balance within the Treasury. Currently, “[e]ven after the Federal Reserve and the Treasury reached an accord delineating their respective responsibilities, the System often suspended monetary-policy actions in deference to the Treasury’s debt-management needs” (Humpage, 2014). Therefore, it is hard to take the Federal Reserve Bank’s statement that they are an independent entity seriously when they have been known to be influenced by the actions and decisions of the US Treasury.

        Furthermore, the Federal Reserve also has extensive history and interactions with Congress. The Federal Reserve was created by Congress. Consequently, Congress holds the ability to completely abolish the Federal Reserve if it wanted to by the Federal Reserve Act of 1913, which is what they did to the First and Second Banks of the United States. Although Congress has no direct say in the monetary policy decisions the Federal Reserve makes, there have at times been congressional threats against the Federal Reserve. These threats include the auditing of the Federal Reserve’s expenditures, putting the secretary of the Treasury back on the Federal Reserve Board, repealing the Fed’s budgetary autonomy, threatening to impeach the Chairman of the Federal Reserve, abolishing the Federal Open Market Committee (FOMC), and politically appointing FOMC members (Boettke et al., 2013). Thus, the Congress does exert a certain degree of power over the Federal Reserve that could potentially influence the Federal Reserve’s decisions. It is important to question “whether a monetary authority can be truly independent if legislators can, if pushed, ‘…modify the effective monetary constitution,’ by imposing specific regulations or, in the limit, by abolishing the independence of the monetary authority itself” (Boettke et al., 2013). Since the Federal Reserve and Congress both have a say in different aspects of monetary policy that affect the American economy, it is no surprise that at times their interests intertwine.