Fed Independence and Comparative Institutional Analysis
| Peter Klein |
I’ve written before on Fed “independence” and why I don’t support it. The vast majority of economists, especially the more prominent ones, are strongly in favor of independence and against Congressional attempts to limit the Fed’s discretion in monetary and regulatory policy. The standard argument is that a “politicized” — i.e., accountable — central bank will be more expansionary than an unaccountable central bank, assuming that credit expansion affects output first and prices (inflation) second. Last week’s piece by Kashyap and Mishkin follows this script. On the face of it, this seems absurd, as — to take only the most obvious example — the Greenspan-Bernanke “independent” Fed has been the most expansionist in modern history, with a ballooning money supply throughout the 2000s and near-zero interest rates and injections of giggledysquillions of dollars into the banking sector in the last 18 months. The independence crowd cites cross-country studies finding a negative correlation between central-bank independence and inflation, but these studies are controversial (many problems with reverse causation, omitted variables, sample size, etc.).
My question today is different: Where, in those arguments, is the comparative institutional analysis? After all, in policy analysis, we are always comparing imperfect alternatives. We try to avoid the Nirvana fallacy. Craig does this in his post below, asking if a centralized financial regulator would be less bad than the competing regulatory bodies we have today.
But the macroeconomists entirely ignore this problem. Consider Mark Thoma’s defense of independence:
The hope is that an independent Fed can overcome the temptation to use monetary policy to influence elections, and also overcome the temptation to monetize the debt, and that it will do what’s best for the economy in the long-run rather than adopting the policy that maximizes the chances of politicians being reelected.
This naive wish is simply that, a hope. Where is the argument or evidence that a wholly unaccountable Fed would, in fact, “do what’s best for the economy in the long-run”? What are the Fed officials’ incentives to do that? What monitoring and governance mechanisms assure that Fed officials will pursue the public interest? What if they have private interests? Maybe they’re motivated by ideology. Suppose they make systematic errors. Maybe they’ve been captured by special-interest groups like, oh, I don’t know, the banking industry (duh). To make a case for independence, it is not enough to demonstrate the potential hazards of political oversight. You have to show that these hazards exceed the hazards of an unaccountable, unrestricted, ungoverned central bank. The mainstream economists totally ignore this question, choosing to put a naive faith in the wisdom of central bankers to do what’s right. Guys, have you never heard of public-choice theory?