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The Federal Reserve is not, and should not be, independent


Tim Fernholz gives voice to some slightly heretical thoughts about pulling Ben Bernanke's renomination as chairman of the Federal Reserve and replacing him with a more full-employment oriented leader, like Federal Reserve governor Janet Yellen. But no, you gasp! That would be influencing the Fed!

Well, yes:

Right now, unemployment is a much larger problem than inflation, and creating a specific inflation target would, as Paul Krugman puts it in his discussion of the Japanese case in the 1990s, allow "the central bank to credibly promise to be irresponsible -- to make a persuasive case that it will permit inflation to occur, thereby producing the negative real interest rates the economy needs." Negative real interest rates would be the step beyond the zero-interest rate policy that the Fed is following right now, which is not enough to provide a significant monetary expansion to allow for employment growth.

Bernanke could, conceivably, do something along these lines. But he hasn't yet. On the other hand, if you wanted someone who could credibly promise to be "irresponsible," at least from the view of monetary policy hawks, why not pick someone who Bond Vigilante-types already think is irresponsible (read, cares about unemployment), like San Francisco Federal Reserve President Janet Yellen? Some might claim that this would damage the Fed's "political independence," but actually making use of the main check that the government has over the Fed -- appointing the chairman -- should be seen as within the normal bounds of Fed-government relations.

There are reasons to avoid doing this, of course. As Fernholz admits, the financial markets would freak out, and Obama doesn't want that. And I don't have much of an opinion over whether Bernanke should continue serving or be replaced. But Fernholz's structural point is important: The Federal Reserve is insulated from politics, but it is not, in fact, independent, and nor is it supposed to be.

Presidents need not be afraid of appointing chairmen who represent a break from their predecessors or fall closer in line with the administration's priorities. Indeed, that's actually part of their job description. The Federal Reserve is designed to give the chairman distance after he or she is appointed, but the position is appointed precisely in order to give the more democratic branches control over who serves, and influence over what the institution's priorities are. We may live in the Republic of the Central Banker, but even he serves at the pleasure of the presidency.

Photo credit: Brendan Smialowski -- Bloomberg News.

By Ezra Klein  |  November 24, 2009; 9:19 AM ET
Categories:  Federal Reserve  
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Interesting point. But your closing line ("but even he serves at the pleasure of the presidency") suggests more than power over the nomination. Can the Fed chair be fired at will?

Posted by: retr2327 | November 24, 2009 10:19 AM | Report abuse

Agreed. A lot of good can be done simply by raising the Fed's inflation target from 2% to 3%. The problem is that most central bankers made their careers when inflation was a primary concern and have always given it priority over unemployment.

Posted by: etdean1 | November 24, 2009 10:32 AM | Report abuse

The Fed should target a path for NGDP consistent with stable growth and low inflation.

I'd say let the path start at a period of full employment - 2007Q1 - and have that NGDP path grow at a rate of 5%. We'd have a lot of catch up to do (based on that path, NGDP should be $15.59 trillion vs $14.27 trillion today).

Posted by: justin84 | November 24, 2009 12:01 PM | Report abuse

Better healine:

The Federal Reserve Should Not BE

Interest is the cost of borrowing money. Why are rates not set by supply and demand?
Why do we have artificially set interest rates in the first place?

The continuous overshooting and undershooting of rates is what causes the boom and bust business cycle.

Dump the FED

Posted by: WrongfulDeath | November 24, 2009 12:23 PM | Report abuse

WrongfulDeath: Interest rates ARE set by supply and demand. Lenders set interest rates at whatever the market will bear. (Give or take anti-usury laws.) The Federal Reserve does its work by adjusting supply, and having the market adjust the interest rates it charges accordingly.

The target interest rate is just a target, so that they can have a sense of what a reasonable supply of money would be.

Posted by: usergoogol | November 24, 2009 1:16 PM | Report abuse

Yes, usergoogol, the Fed sets targets, it doesn't set rates. It then attempts to achieve the targets by "market operations" through the New York Fed. In other words, WrongfulDeath has no idea what he or she is talking about, which is unsurprising.

Ezra, the chairman of the Board of Governors does not serve "at the pleasure" of the president, like a cabinet officer. The president can't tell the Fed chairman what to do, and can't fire him (or, some day, her) over a policy disagreement. And Janet Yellen is not a Governor of the Federal Reserve, she's the President of the Federal Reserve Bank of San Francisco, although she was a Governor back in the 1990s.

Posted by: thehersch | November 24, 2009 11:35 PM | Report abuse

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