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Hands off the Fed!

In the face of recent legislative attempts to meddle in the conduct of U.S. monetary policy, Federal Reserve Chair Janet Yellen is vigorously defending the independence of the Fed. Since its creation in 1913, the Fed has been independent from Congress, and there are very good reasons to keep it that way. Giving Congress more control over monetary policy is only advisable if it is expected to yield better economic outcomes, and the chances of that are slim to none.

Janet Yellen speaking on March 18, 2015.
Joshua Roberts | Reuters
Janet Yellen speaking on March 18, 2015.

The official goal of the Fed is to maintain the long-term growth of the country's money supply in a way that fosters the economy's long-run growth potential with specific goals of maximum employment, stable prices (i.e., low inflation), and moderate long-term interest rates. For the most part, the Federal Reserve has done a pretty good job of achieving its goals, especially since the early 1980's. Except for the 2007-8 recession, the U.S. has enjoyed significant economic growth combined with low inflation rates and only infrequent and relatively mild recessions. Congressional meddling in the Fed's business is highly unlikely to produce better outcomes than these.

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Research comparing the performance of central banks that have varying degrees of independence consistently concludes that meddling by politicians is likely to produce much worse economic outcomes, especially regarding inflation. The data show that, among the industrialized countries, those with more-independent central banks benefit from lower and less volatile inflation rates. Further, such countries have similar average long-term rates of real GDP growth and average rates of unemployment as do countries with less-independent central banks. That is, independent central banks produce economic outcomes that are clearly superior to those produced by central banks that are subject to political influence.

Political meddling tends to produce worse outcomes for an economy because politicians think mostly about short-term fixes. They can be tempted to finance deficits by printing money, or to improve their re-election prospects by stimulating the economy in the short run by expanding the money supply, both of which are likely to produce higher inflation later. Unfortunately for us, politicians continually keep an eye on the next election and aren't motivated to think that far ahead.

Members of the Fed Board of Governors are appointed by the president and confirmed by the Senate to 14-year terms. Being free from the short-term pressures of re-election gives them a much longer view of economic policy-making than Congress will ever have and also means they will be around to face the consequences of any errors they might make. This longer view creates a commitment to policies that are best for the economy in the long term, even if they aren't always popular in the short run. Those with longer memories will recall former Fed Chair Paul Volcker increasing interest rates in 1980 to counter double-digit inflation. It was tough medicine at the time, but paid huge dividends over the next few decades.

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Greater congressional control would weaken the Fed's commitment to the long term, resulting in higher inflation without improving other aspects of economic performance.

Given Congress' record on fiscal policy and inability to eliminate chronic federal deficits, do we really want them tampering with monetary policy as well? To Congress we say, "Hands off the Fed!"

Commentary by Paul Johnson, professor and acting chair of economics at Vassar College and Robert Rebelein, associate professor of economics at Vassar. Rebelein was also senior economist with the White House Council of Economic Advisors in 2008 and 2009.