How to Promote Fed Independence: Perspectives from Political Economy and History

• Author: Charles W. Calomiris
• DOI: http://doi.org/10.1111/jacf.12373
• Published date: 01 December 2019
• Date: 01 December 2019

IN THIS ISSUE:

e Fed

and the

Financial

System

VOLUME 31

NUMBER 4

FALL 2019

APPLIED

CORPORATE FINANCE

Journal of

10 Hamilton and the U.S. Financial Revolution

Richard Sylla, New York University and NBER, and David J. Cowen, Museum of American Finance

16 A Limited Central Bank

Charles I. Plosser, Former President and CEO, Federal Reserve Bank of Philadelphia

21 How to Promote Fed Independence:

Perspectives from Political Economy and History

Charles W. Calomiris, Columbia University and The Hoover Institution

43 e Great Crash of 1929: A Look Back After 90 Years

Robert F. Bruner, University of Virginia, and Scott C. Miller, Yale University

59 e Strange and Futile World of Trade Wars

Steve H. Hanke and Edward Li, Johns Hopkins University

68 Monetary Policy Implementation: Making Better and

More Consistent Use of the Federal Reserve’s Balance Sheet

Peter N. Ireland, Boston College and the Shadow Open Market Committee

77 e Fed’s Communications: Suggestions for Improvement

Mickey D. Levy, Berenberg Capital Markets

86 FinTech, BigTech, and the Future of Banking

René M. Stulz, The Ohio State University

98 Will Blockchain Be a Big Deal? Reasons for Caution

Craig Pirrong, University of Houston

105 Two Modes of Investment Banking:

Technocrats, Relationship Managers, and Conict

Alan D. Morrison and William J. Wilhelm, Jr., University of Oxford and University of Virginia

118 Dividend Consistency: Rewards, Learning, and Expectations

David Michayluk and Scott Walker, University of Technology Sydney,

Karyn Neuhauser, Lamar University

129 e Reference-Driven College Paper

(Or Why Your Students Should Read the JACF)

Joseph W. Trefzger, Illinois State University

21

Journal of Applied Corporate Finance • Volume 31 Number 4 Fall 2019

P

ese ve questions have been addressed more or less continu-

ously in policy debates about the institutional design of central

banks, especially since they were all considered in Milton

Friedman’s classic 1962 article.¹ Yet despite many decades of

thinking, a working denition of Fed independence remains

elusive, judgments dier widely about the extent and even

the feasibility of such independence, and policy advocates

continue to propose very dierent kinds of rules for protect-

ing and promoting it.

In this article, I show that convincing answers to these

ve fundamental questions about Fed independence must

begin by recognizing the status of the Fed within American

democracy, which can be understood only from a historical

perspective. As a matter of the logic of political economy,

*For helpful discussions, I thank Don Chew, Stephen Haber, Marvin Goodfriend, Allan

Meltzer, David Wheelock, Geoffrey Wood, and Larry Wall.

1 Friedman (1962) considers three possibilities: (1) a fully discretionary, indepen-

dent central bank; (2) a commodity standard; and (3) the “monetary rule” that Friedman

himself proposed and with which his name is associated. One can conceive of a more

exible arrangement than a rule—one in which the central bank has a clear statutory

mandate to articulate and follow an explicit rule (such as the “Taylor Rule”), but which

it is also permitted to deviate from under extreme circumstances, provided it supplies an

explanation. Such a construct recognizes—following Capie and Wood (2012), and in the

spirit of Meltzer (2012)—that inexible rules are not credible, especially in the presence

of nancial crises. Full citations of all articles are provided in the References at the end.

that means not only identifying the current statutory powers

of the Fed, but analyzing how changes in those powers have

happened in the past. All political constructs—including the

Fed—are the result of a political bargaining process. Indepen-

dence is impossible to dene without considering the process

by which power is delegated or withdrawn.

A discussion of Fed independence is also inevitably inter-

twined with a discussion of policy frameworks that promote

or discourage independence. Advocates of Fed independence

have been keenly aware of how independence is shaped by

the objectives and procedures of policy, and not just by the

institutional structure of the Fed. For example, as Friedman,

his well-known monetarist colleague Allan Meltzer, and

many other advocates of monetary rules have recognized for

decades, one of the main advantages of adopting a rule is

that it makes monetary policy less subject to political interfer-

ence—motivated by, say, short-sighted demands for temporary

stimulation of the economy. If the Fed is following a rule, the

reduction in discretion that comes with adherence to a rule

makes it easier for the Fed to defend its policy actions to

politically motivated critics in Congress or the Administration.

When considering the political bargains that give rise to

changes in Fed powers, it is crucial to consider decisions to

by Charles W. Calomiris, Columbia University and The Hoover Institution*

ractically everyone can agree that central bank independence is desirable, at least

when exercised within the connes of a clear mandate to guide central bankers that

ensures their accountability to their citizens. Yet differences persist about the answers to ve

fundamental questions about central bank independence and the mandates within which

that independence is expressed. What is the precise meaning of independence? What does

independence depend on? Why is it desirable? How independent is today’s Federal Reserve

System, and how independent has the Fed been over its 100-year-plus history? And what

can be done to strengthen Fed independence by changing the current mandate within which

the Fed operates?

How to Promote Fed Independence:

Perspectives from Political Economy and History