Federal Reserve independence

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Source: Remarks by Governor Laurence H. Meyer at the University of Wisconsin, LaCrosse, Wisconsin, October 24, 2000

The Politics of Monetary Policy: Balancing Independence and Accountability

It is widely believed, at least among central bankers, that "independence" is a prerequisite for achieving the goals that traditionally have been assigned to central banks--specifically for achieving price stability. "Independence" does not mean literally independence from government, because central banks here and abroad are almost always part of government. The relationship of central banks to the rest of government is, in practice, therefore much more complex than the term "independence" might suggest.

The motivation for granting independence to central banks is to insulate the conduct of monetary policy from political interference, especially interference motivated by the pressures of elections to deliver short-term gains irrespective of longer-term costs. The intent of this insulation is not to free the central bank to pursue whatever policy it prefers--indeed every country specifies the goals of policy to some degree--but to provide a credible commitment of the government, through its central bank, to achieve those goals, especially price stability.

Even a limited degree of independence, taken literally, could be viewed as inconsistent with democratic ideals and, in addition, might leave the central bank without appropriate incentives to carry out its responsibilities. Therefore, independence has to be balanced with accountability--accountability of the central bank to the public and, specifically, to their elected representatives.

It is important to appreciate, however, that steps to encourage accountability also offer opportunities for political pressure. The history of the Federal Reserve's relationship to the rest of government is one marked by efforts by the rest of government both to foster central bank independence and to exert political pressure on monetary policy.

The purpose of this paper is to clarify the relationship of central banks within government, to explain the nature, degree of, and rationale for the independence afforded to many central banks--with a special focus on the role of the Federal Reserve within the U.S. government--and to discuss the balancing of independence and accountability in principle and in practice.

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