From time to time we get questions about whether partisan politics will interfere with the Federal Reserve’s independence. Investors are concerned that political pressure would lead the Fed to keep interest rates too low for too long and stoke inflation, and that of course would be bad for the bond market.
I’m Kathy Jones and this is Bond Market Today.
While the Federal Reserve is a political institution in the sense that it was created by Congress, its members are appointed by the president and confirmed by Congress, there are good reasons to believe that it can maintain its independence from political influence. The Federal Reserve’s design can help it stay independent of political pressure. The Fed consists of twelve regional banks that are spread out all over the country, and those regional banks represent the constituents in those regions, businesses and individuals.
The committee that actually sets monetary policy, the Federal Reserve’s Open Market Committee, consists of seven members of the Board of Governors, plus the president of the New York Federal Reserve, who’s a permanent voting member, and then four members who rotate from the regional Fed banks, and they rotate on an annual basis. Now, the members of the Board of Governors serve 14-year terms, which means that they outlast most political administrations; and then the rotation of the regional Fed presidents as voting members allows for a diverse and shifting view of the economy and of policy at often times.
Moreover, the Federal Reserve doesn’t make fiscal policy. They don’t get involved in appropriations, that’s Congress’s purview. The Fed’s mandate is to set policy, to promote full employment, and to keep inflation low.
Historically, administrations have all types have advocated for low interest rates from the Fed, because keeping interest rates low tends to boost the economy, but ever since the surge in inflation in the late 1970’s and early 1980’s, when the Fed had to take drastic steps to get it under control, the Fed’s credibility in setting monetary policy has been linked to its independence. Allowing partisan politics to interfere with setting policy could result in reversing 40 years of hard-fought gains from the Fed in fighting inflation expectations.
We aren’t really seeing evidence that the Fed is bowing to political pressure, but what we have seen is that various members of the Fed have stepped up their communications with the public, and trying to explain the reasoning behind their policy decisions, what indicators they’re watching, and how they go about assessing the economy and inflation; and those efforts can help assuage some of the concerns about the Fed’s independence from political pressure.
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