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Central Bank Independence

By Anonymous

Dean Baker, in an otherwise excellent post describing his preferred conditions for a bailout, writes:

The structure of the Fed should be changed so that all the officials with a direct say in monetary policy are appointed by the president and approved by Congress. The Fed is supposed to act in the public interest, not in the service of the financial industry. It is disturbing that the public is being represented in this debate over the restructuring of the financial industry almost entirely by top figures from the financial industry. This would be comparable to having national policy on the auto industry determined by former top officials with the United Auto Workers. It is difficult to believe that the views of Treasury Secretary Paulson and other government officials from the financial industry are not influenced by their long association with the industry.

This problem should not be worsened by giving the banking industry a direct voice in the conduct of monetary policy, by allowing it to appoint Federal Reserve district bank presidents who take part in open market committee discussions. There should be a strict separation between the conduct of open market policy, which should be done exclusively by people appointed by the president and approved by Congress and the responsibilities of the district bank presidents. The banking industry deserves no special voice in the conduct of monetary policy.

I half-agree with this. Baker is right that we should change the way that monetary policy is conducted. But he's wrong about the nature of the problem, and thus his proposed solution is inadequate.

Baker is wrong when he says that "[t]he Fed is supposed to act in the public interest." No, actually it's not, and that's part of the problem. I can understand why he would assume that the Fed is supposed to act in the public interest?given the importance of monetary policy, that should be a no-brainer. In selecting the Board of Governors (all 7 of whom sit on the OMC), 12 U.S.C. 241 states:

the President shall have due regard to a fair representation of the financial, agricultural, industrial, and commercial interests, and geographical divisions of the country.

So in selecting the Board of Governors, the president isn't required to consider the "public interest," but rather the interests of a few sectors. Things don't get any better when the Fed Governors get to the Open Market Committee. 12 U.S.C. 263(c) states:

The time, character, and volume of ... open-market operations shall be governed with a view to accommodating commerce and business and with regard to their bearing upon the general credit situation of the country.

The closest thing we get to a mandate to act in the public interest is the requirement that the OMC consider the consequences of open-market operations on "the general credit situation of the country." But that comes right after the part about how open-market operations must be conducted "with a view to accommodating commerce and business." Inspiring stuff.

Baker is right that all 12 members of the OMC should be appointed by the president and approved by the Senate. (I assume by "approved by Congress" he meant "approved by the Senate," since he surely knows that including the House would needlessly politicize the process, and his main objection is that the 5 regional presidents on the OMC are basically hand-picked by the banking industry.) But the Open Market Committee's legal mandate must also be changed, so that when the "financial, agricultural, industrial, and commercial interests" diverge from the public interest, the Fed's loyalties lie unambiguously with the public.

Full post as published by Economics of Contempt on September 20, 2008 (boomark / email).