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Central Bank Independence is Overrated

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I wrote the following on June 16th, 2009:

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Central Banks, should they exist, should be able to do what is right for monetary policy, which includes regulation of credit.  In a fiat money world, where credit exists as electronic entries, credit is money.

But wait, what if central bank independence is compromised from within?  What if voluntarily becomes the lap dog of the President, Treasury, or Congress?

It takes a bold man to stand up to the powers that be, and the Fed has had its share of them.  Marriner Eccles opposed Truman.  William McChesney Martin, Jr. stood up to Presidents and Congress for his long term as Chairman.  Paul Volcker blew cigar smoke at representatives and Senators as he restored sound money to the US amid screams of pain in the economy.

Central bank independence doesn’t mean squat unless the central bank uses it!

In the name of independence, for fear that the President or Congress would restrict the central bank, many Fed Chairmen have given in to the powers that be:

  • Ben Bernanke, rescued entities that he should not have rescued, and established lending programs that use the national credit to benefit a minority of participants.  These actions should have been taken by Congress, if done at all, so that the voters could decide whether it was right to do it or not.  Bernanke validates the idea that the government keeps the Fed around to do what it cannot do constitutionally.
  • Alan Greenspan threw liquidity at every little and big problem, and was slow to withdraw liquidity, pushing the US slowly but surely into a liquidity trap, which Ben Bernanke was saddled with.
  • G. William Miller and Arthur F. Burns, who facilitated the inflation of the ’70s, at the behest of Nixon and Carter.
  • Daniel R. Crissinger and Roy A. Young, who facilitated the loose monetary policy of the ’20s.

Central bank independence means risking your own tenure for the good of the institution.  Marriner Eccles and Paul Volcker did not get reappointed because they offended the President.    Central bank independence does not mean compromising in order to protect against micromanagement.  Independence means being a man, and telling the President and congressmen that you will do what is right to preserve sound money, regardless of the consequences.

The Fed as Systemic Risk Regulator

I have suggested in the past that the Fed should regulate systemic risk as an aspect of its mandate only because they are the biggest creator of systemic risk through loose monetary policy.  I am not suggesting this on the basis of competence — that is ridiculous.  But on the basis of modifying the behavior of the Fed to make it more resistant to loosening rates early because of systemic risk concerns — that makes sense, because it will increase the emphasis on a sound currency.

Now, many economists are pleading with Congress to be gentle on the Fed because an independent Fed is critical to sound economic policy.  That would be true if the Fed were willing to take politically unpopular actions that were in the best interests of the economy.  Sadly, that is not true of the present Fed.  They do what the politicians want, and give the politicians cover, because the politicians can point at the Fed as the actor, via the rubric of “Central Bank independence.”

I say that the Fed needs more accountability and transparency to Congress, and ultimately to the American.  The quasi-public, quasi-private nature of the Fed needs to be changed to public or private.  Section 13.3 of the Federal Reserve Act, which allowed for the most egregious bailout actions, should be repealed. If bailouts need to be done, let Congress do them, and let them take the heat for their actions.

Not only should the Fed be audited as any large public or private organization, but if they are a public organization they should respond to the FOIA requests from major news organizations (Bloomberg, Fox Business, etc.) without hiding behind technicalities of protecting business secrets.  The insurance industry regularly reveals detailed data on their operating companies, with little seeming harm.  The banks can afford to do the same.

Power without accountability should be foreign to our republican form of government.  Control of our currency rightfully belongs to Congress, and Congress should tighten controls on the Fed so that its degree of independence is limited to the ordinary matters pertaining to a central bank — preserving the soundness of the currency.  Its competence there has been limited; but hey, at least focus on the basics would restore confidence in an institution that no longer has the confidence of the American people.

“Central Bank independence” is a nice phrase, but to the economists who petitioned Congress to preserve the status quo, I would simply ask this: How and from what should the central bank be independent?  To whom and in what ways should it be accountable?

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Central Bank independence does not mean they can do whatever they want.  It does mean:

  • Resisting Congress if the are pushing for debasement.
  • Resisting the Executive branch if they are pushing for debasement.
  • Resisting the people if they are pushing for debasement.

It means taking the hard road, the unpopular road, and doing what is right in the long run for all Americans, which means having a sound currency, which will promote growth on its own, and not try to goose growth through “stimulus.”  That’s just pandering to the politicians, which makes you no better than them.

In short, Central Bank independence means if the politicians want it, you do not give it to them.  Be a man, protect the currency, and ignore the screams.

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David Merkel

David Merkel

2010-present, David is working on setting up his own equity asset management shop, tentatively called Aleph Investments. From 2008-2010, he was the Chief Economist and Director of Research of Finacorp Securities. He did many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, he was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. He also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, he was a leading commentator at the investment website RealMoney.com. His background as a life actuary has given him a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that he deals with in this blog. All of these goals rely on the help of Jesus Christ and his readers.
David Merkel

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