Central Bank Independence-Becker

Governments that control central banks have often used their power to increase the money supply and create inflation. A growth of the money supply increases the revenue collected by the government through an inflation imposed tax on the holders of money.

These and other abuses of governmental power over central banks helped create the intellectual support for independent central banks. During the past several decades several central banks, such as the Mexico central bank, have become more independent of their government.

I have little doubt that central banks should have considerable independence Yet complete central bank independence from politicians does not seem desirable since banks also can abuse their powers. At times they can be tone deaf to what is happening in the economy, and at other times they are too much under control of the private banks that they regulate.

An analogy is often drawn between an independent judiciary and an independent central bank. Just as an independent judiciary often prevents legislatures and heads of governments from abusing their power to formulate and interpret laws, so an independent central bank is supposed to prevent governments from inflating the money supply, and in other ways creating monetary mischief. Yet the analogy between central banks and the judiciary is incomplete and not perfect. If the Supreme Court gives an unpopular opinion, such as its recent decision on the unconstitutionality of bans on spending by corporations during elections, that does not directly reflect on the governing policies of the President or Congress. Indeed, President Obama has openly criticized the opinion and clearly expressed his opposition. On the other hand, when central bank policies help create inflation or unemployment, the governing party will be blamed because the electorate cannot distinguish the effects of central bank behavior from the effects of presidential and legislative decisions.

Milton Friedman in “Should there be an Independent Monetary Authority” (1962) and elsewhere argued against complete independence of the Fed and other central banks because that would give too much power to the top bank officials. He also opposed making a central bank subservient to political leaders because that could lead these leaders to misuse the bank’s powers in order to promote their short –term political gain. His solution was a monetary rule, such as a fixed growth rate in the money supply. Such a rule would make many important central bank decisions completely automatic, and independent of the desires of both central bank heads and government officials. Taylor-type interest rate rules that have greatly influenced some central banks are generalizations of Friedman’s rule on money supply growth that are linked to inflation and the growth of GDP. Taylor-type rules also can operate automatically, and could be largely independent of both central bankers and politicians.

Yet even if a central bank followed a rigid rule to determine its interest rate and money supply policies, it would be necessary to periodically evaluate how well the rule was working. And since central banks are unlikely to continue to follow a fixed rule in the face of a financial crisis, evaluations of its discretionary decisions are also necessary. While the bank should provide its own evaluations, these would tend to be biased toward justification of what it had done.

This is why I support substantial but not complete independence of central banks from legislative and executive oversight.  Such oversight can force central banks heads to justify what they did in a public and open arena. The need to provide regular reports on its behavior to legislative committees would bring out mistakes made by the central bank. It would also induce central bankers to take more careful decisions since they would anticipate having to justify what they did in a public forum.

The US approach to the Fed makes a reasonable compromise between independence and oversight. The President appoints, subject to Senate approval, all seven members of the Board of Governors of the Federal Reserve for 14-year terms. Neither the President nor the Senate can remove any member prior to the expiration of their terms because of disagreements with bank policies. The President chooses, subject also to Senate approval, the Chairman of the Board, the most powerful position on the Board, from among the sitting Governors. The chairman serves for four years and can be reappointed. The chairman must report twice a year to Congress on the Fed’s policies, and he is asked to testify on other occasions before Congressional committees. He also collaborates with the Treasury on various occasions, as during the 2008-09 financial crisis.

Some critics believe the Fed has too much independence from Congress and the President. Following this line of criticism, Representative Ron Paul of Texas in 2009 introduced a bill that would provide for greater Congressional oversight of the Fed. Others believe that the Fed and other central banks have too cozy a relation with governments, and that political pressures excessively influence central bankers to conform to short-term political wishes.

The best way to help meet both objections is to make public all the Fed’s decisions (and that of other central banks), with no more than a short lag. Rather than being an asset, central bank secrecy is a handicap to businessmen and consumers who make investment and other decisions that are affected greatly by what the bank does.  To maximize public information, the central bank, whenever feasible, should follow known interest rate and money supply rules that are clearly related to the rate of inflation and the degree of slack in the economy.

Under these conditions, present laws on the length of the chairman’s term and that of the other members of the Fed’s Governing Board, and the laws requiring periodic reports of the chairman before Congress, would be effective. A system that has the Fed following rules that govern its policy decisions, combined with some discretionary authority in crises, and also with some congressional oversight would provide a reasonable mixture of central bank independence and control by Congress.

Comments

[joshua blumenkopf]

While I agree that the Fed should have some degree of independence from the government through long,irremovable terms, there is no reason why the banking industry through the local federal branches should have any say in a body that they have a direct interest in which may be different than that of the general populace. This influence is especially unsettling under some proposals that would give the Fed some power to regulate the banks.

[Jack]

Joshua: I've similar thoughts. Is an all banker Fed too incestuous? If, as some claim, low rates were a contributor to the housing bubble, they met regularly for eight years as all sorts of anomalies showed up in housing/banking. Were they blind to it? Or was their heads turned because banking was doing so well? Or did they see, but not have the tools to deal with it four or so years in?

It's tempting to have non-bankers on the fed. Surrounded by bankers and with expert testimony surely leaders in other fields can grasp the issues and bring the wisdom of a differing perspective. But would seating someone from business, labor or non-banking academics politicize the process and Ha! take away from the illusion that Fed decisions emanate from unanimous agreement among wise men well above petty politics?

For most bodies 14 year terms sound very long; perhaps staggered ten year terms would do as well in limiting short term political influence.

[Don the libertarian Democrat]

I'm a follower of Friedman on this issue, but you make good points, and I could live with your suggestions.

[NEH]

The only question in my mind is "How do we maintain a constructive balance between independence and control"? As we have seen in most "balanced" systems, they are much like pendulums swinging from one extreme to the other. The only time they strike a true balance is when they are passing through it from one extreme to the other.

This is the tough nut to crack and is time and situationally dependent. Ahh..., the joys of Social, Political & Economic Engineering.

[Jack]

NEH, Ha! Like capitalism itself; ever seeking the elusive equilibrium, and at times having no more stability than a kite with no tail, going far astray. Such is human nature. In some local and even statewide processes (AK) I've seen good process bring forth more intelligence and better policy than could have been designed by any one person. (Usually lobbyists are not there to hijack the conclusions and in a small state those who infiltrate with self-promoting agendas are known or quickly found out.)

BTW....... a close decision on what candidate to support I've a theory that those who like people in general, women, even perhaps too much and pets are a better gamble than Machiavellian loners like Nixon or those overly imbued with ideology like Bush the younger. FDR, Truman, Ike, JFK (after he grew in office) LBJ (but for his curious blindness to the wasteful futility of the Viet War) Carter, Reagan kinda makes the cut, Clinton........ most of whom would be more reluctant to order our people into wars without strong justification.

[NEH]

Jack, I never did like Dulle's Dominoe Set and as Johnson put it in unguarded moment, "Those people #*!%@&" lied to me." Sounds a lot like what's coming off Capital Hill these days. Whether it's Congressmen, Senators, Wall St. Exec's. or BP, TransOcean or Halliburton. And we wonder why the Country's so screwed up. It's all about the roundabout and CYA. Meanwhile, we're all scrambling to keep from being pushed over the edge into the Abyss.

[Stan Sitruc]

I think this is the wrong argument. A citizen should be able to opt out of the federal reserve system if he believes the Fed is too political or too close to member banks. We are prevented from exercising our freedom to choose because we are forced to do our business in US dollars. We should end legal tender laws and let citizens conduct their business in Gold, DMs, Yen, bullets--whatever currency they want. Also we should not be taxed by government caused inflation.

It is also disappointing to see the argument put forth that does not acknowledge high inflation without CPI increases. Based on the tremendous amount of productivity increase over the past 20 years, one would expect CPI to be negative for the vast portion of those 20 years.

We should also have the right to choose banks that are not fractional reserve banks, banks that are outside of the Federal Reserve System.

[Jack]

Stan: When we were on the "Gold Standard" Americans were not allowed to own gold as a store of value, thus we were virtually mandated to use US currency, albeit that currency was theoretically convertible to gold or silver.

Today? if you think the Fed is pursuing inflationary policies you're absolutely free to convert your savings into gold or any other currency. Thus......... perhaps we're on the ultimate gold standard today.

"over the past 20 years, one would expect CPI to be negative for the vast portion of those 20 years."

Ha........ nearly my lament as well, though I focus more on ALL of the wage gains of that era having gone to the top 10%. But you could look at it that prices are too high as in terms of what wages are paid. For many things, especially medical care, prescription drugs, on down to cell phones and cable TV we pay far more than those of other nations.

But! the Fed does not set prices and you'd have a tough, tough job making a case for prices being high due to "too many dollars chasing too few products" as the most of the world is and has been suffering from over capacity -- under utilization of production facilities.

There seems a reaction of blaming the wholesale corruption of the banking and R/E system on the Fed, but truth is corruption is corruption and what took place over the last decade could have as easily taken place under any central banking system or a system not having a central banking system -- and been more disaterous.

[joshua blumenkopf]

Stan: Do you actually think that it would be practical to conduct business in currencies other than the dollar. No consumer would go to a store that only allowed yen. Additionally DMs don't exist anymore.

[NEH]

Stan, The U.S. once had a system where every bank could issue its own script. Talk about a disaster and it's negative impact on trade; locally, nationally and internationally.

Personally, I prefer rocks as script. Thank God for the Commerce clause.

[Stan Sitruc]

To those that responded to my comments, thank you for giving them your consideration.

I feel compelled to respond though:
1)Prior to 1933 we did not have any legal tender laws and our currency was gold. Additionally our contracts contained gold clauses that allowed payment in dollars or onces.
2)Today, if you convert your dollars to gold and then convert back to dollars to use in a transaction, you will pay a capital gains tax on the value increase of gold relative to dollars.
3) The Fed does set prices--it sets the price of money (interest rates)
4) With the destruction of the Euro, we will have DMs very soon. Plus the Germain people are converting their currency to gold now. This is why the price of gold is increasing even though the dollar is also increasing relative to the Euro.
5) Lastly, when we were on a true gold standard with individual rights to hold gold, the United States grew from one of the smallest economies in the world to the world's largest and became the leader in international trade.

Thanks again for reading my comments.

Stan

[Stan Sitruc]

Sorry, I met German people, not germain people....

[NEH]

Stan, Most Germans I know are "germane" if not "germain". And is it scrip or script? Ahh... the joys of English and phonetic spelling.

Preahps tihs Bolg needs a sepll chckeer. Is Cambridge right?

[lady kingdom]

very great overview about central bank ...

regards

[Abuhatem]

I went to a conference in monetary economics at the Heritage Foundation a month and a half ago with Steve Hanke of John Hopkins and the Cato Institute, Robert Mundell the Nobel Laurette, and Judy Shelton of the Atlas Foundation and formerly Jack Kemp's economist.

Mundell argued for a global currency with a global central bank which would reduce currency conversion problems and enhance global trade. Hanke argued the case for fixed exchange rates based upon a rule. But, even though this post makes a good case for our current Fed system but more rule-based and standardized and subject to audits, I agree with Judy Shelton who said let's all go back to gold.

All of these problems outweigh the benefits and I think that the, formerly seen as fringe, case for free banking is making more and more sense after the crisis of 2008, for instance see Joseph Salerno at the Cato Institute, Hayek, and others. Shelton had a good article here:

http://online.wsj.com/article/SB123440593696275773.html

[NEH]

What's all this talk about a return to a "Gold Standard"? The only value gold really has is as an industrial commodity. I won't even mention the issue of "Bi-metalism". Remember gold equals "Stagflation".

"You will not crucify us on a cross of gold"! W.J. Bryan

[sesli chat]

The only question in my mind is "How do we maintain a constructive balance between independence and control"? As we have seen in most "balanced" systems, they are much like pendulums swinging from one extreme to the other. The only time they strike a true balance is when they are passing through it from one extreme to the other

[air jordans]

It is not true suffering ennobles the character; happiness does that sometimes, but suffering, for the most part, makes men petty and vindictive. Do you understand?

[nfl jerseys]

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legislation to vote for it. Now with Obamacare we are seeing the same scenario playing out again as the legislation stalls in the House

[oil paintings]

I am just new to your blog and just spent about 1 hour and 30 minutes lurking and reading. I think I will frequent your blog from now on after going through some of your posts. I will definitely learn a lot from them.

[supra shoes]

bank,it is used for us.We need it in the life.
I hope the bank can more and more useful.

[industrial deafness]

It is very difficult to have any banks to help communities.

[搜索引擎营销]

动感超人是小新最喜爱的卡通形象，时尚、动感、叛逆和自由，是小新最好的朋友。
by 搜索引擎营销

[搜索引擎营销]

动感超人是小新最喜爱的卡通形象，时尚、动感、叛逆和自由，是小新最好的朋友。
by 搜索引擎营销

[搜索引擎营销]

蜡笔小新最最崇拜动感超人，我也非常喜欢动感超人。