By Narayana Kocherlakota for Bloomberg
Throughout the developed world, central banks enjoy a large measure of independence. This is considered desirable because it guards against elected officials’ preference for overly easy monetary policy, as a means to generating jobs and votes.
But what if the central bank wants easier money than politicians do? This has been the case in the U.S. for much of the past decade, and it raises important questions about how independence should be defined.
Consider the situation in late 2010. The Republican party won a huge victory in the midterm congressional elections, at least in part thanks to voters’ unease with the $800 billion fiscal stimulus package that the Obama administration adopted the previous year. The newly elected Republicans largely opposed additional stimulus as a way of addressing the protracted recession.
Yet one day after the election, with unemployment still close to 10 percent and inflation falling toward 1 percent, the Federal Reserve began a new round of bond-buying designed to provide added economic stimulus (a policy that I, as a Fed official at the time, supported). This was no isolated event. Throughout the recovery, the Fed systematically sought to boost growth and inflation even as Congress made choices — such as the budget sequestration of 2013 — that seemed deliberately intended to constrain them.
At first glance, the Fed’s policy choices could be seen as a great example of how an independent central bank works: By design, it acts in isolation of, and possibly in contradiction to, the wishes of the public’s elected representatives. Stimulus was amply justified given the Fed’s mandate to seek maximum employment and price stability. Indeed, I’ve argued that it could and should have done more. It was right about the economy and Congress was wrong.
Still, there’s something wrong with this picture. It has to do with the governance of central bank policy. Congress has given the Fed — a group of unelected technocrats — the power to pursue a more pro-inflation and pro-growth policy than the public’s elected representatives desire. What is the justification for this delegation?
As far as I know, the vast theoretical and empirical academic literature addresses central bank independence only as a way to counter the short-term pro-inflation biases of elected officials. It doesn’t explain why central banks should be allowed to do the opposite.
One argument, I suppose, could be expertise: The unelected technocrats just know a lot more about monetary policy than Congress does. But, as someone who’s been one of those technocrats, I’m leery of this argument. The aura of expertise can end up being a way to hide political biases — biases that should really be up to the electorate to adjudicate.
To arrive at a more defensible approach, Congress might have to rethink central bank independence as it is enshrined in the Federal Reserve Act. It could, for example, periodically establish a lower bound for the level of interest rates and an upper bound for asset holdings, leaving the Fed free to choose a higher interest rate and a smaller balance sheet. This would give the central bank ample power to keep inflation in check, but would prevent monetary policy from being too much easier than what Congress and the voters desire.
To be sure, this could on occasion prevent the Fed from doing the right thing when Congress is wrong — as it did in 2010. But over the longer term, it would preserve the most important part of the central bank’s independence, shielding it from accusations that it has become too unaccountable to the people.