Who Really Controls Fed Policy?

June 22nd, 2011 at 9:59 pm | 3 Comments |

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One question that has always hung over Ben Bernanke’s press conferences is: “Why are you doing this?”

Bernanke’s push for increasing transparency at the Federal Reserve seemed poorly timed since it has come right as Fed skeptics are strongest in Congress, whether the skepticism comes from Ron Paul or other politicians.

During his press conference today, Bernanke suggested that if the Fed can be more transparent and gain the trust of Congress, then it might be able take on more innovative policies such as inflation targeting. This would be great if it were true — but it’s unclear that more press conferences are increasing trust in the Federal Reserve.

Currently, the Federal Reserve sets monetary policy usually by announcing what it’s interest rates are, or by announcing if it will conduct large asset purchases. If it adopted an inflation target, the Federal Reserve would announce a goal for inflation that it wants to achieve (for example, two percent) and its success in policy making would be determined by how closely all its activities meets that target.

Bernanke is a self-described “ longtime proponent of an inflation target” and was asked directly about how the Federal Reserve could adopt this policy in practice. He suggested that the policy could take time to develop since it would need to be explained to members of Congress. He also warned that the public might not understand the benefits of inflation targeting and they would fear the Federal Reserve was intentionally abandoning its mandate for employment:

“It is very important first that we communicate to the public what we are doing. Without sufficient explanation and background many people might think are abandoning our employment targets. We need to make sure it’s well understood by the public and by congress that having a target would not mean we are abandoning the other leg of the dual mandate.”

Left unsaid in Bernanke’s response was that many people might also be terrified of the Fed intentionally trying to increase inflation due to the fear of inflation among many members of the population.

As for why Congress would need to be consulted:

“We might have the legal authority to do this, but I think we need some buy in from the administration and Congress to take this step.”

Bernanke said there is “nothing imminent” on the horizon and that actions such as this press conference are part of a longer term strategy of increasing transparency.

The exchange was a revealing look at the limits of the Federal Reserve’s independence. On the one hand, Bernanke believes he has the legal authority to conduct inflation targeting if it would be better policy. On the other hand, he wants to get stakeholders behind him first –but given how skeptical many in Congress are of the Federal Reserve, that doesn’t seem likely to happen.

Given how timid the Fed can be on some policy questions, it’s remarkable that politicians such as Newt Gingrich are claiming the Fed is violating the “rule of law.”

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3 Comments so far ↓

  • valkayec

    The Fed has certainly made some egregious mistakes over the last decade. However, the dual mandate of the Fed is to balance employment with inflation. Congress, in its infinite lack of knowledge, spurred on by Newt and Ron Paul, have made it even more difficult for the Fed to keep its dual mandate. They are a thorn in the side of good economic policy.

  • sparse

    i worry that if there were to be a specific target for inflation, say 2%, that that number could become a political football.

    i cannot believe i just made an argument against transparency in my government. but i guess that is a sign of how little i distrust the house and senate, not how little i trust the fed.

  • ottovbvs

    Sometimes Noah’s naivete amazes. Being the chairman of the Fed has always been an econo/politico position. To start with he’s appointed by the president and this means that as well as technical competence he’s expected to be broadly in sympathy with the economic outlook of the president who appoints him. This was true when he was originally appointed by Bush (Bernanke was broadly conservative) and when he was re-appointed by Obama (The great recession had caused him to have something of a conversion to a more Keynesian outlook). Thereafter the machinery of economic management is so intricately interconnected with both govt fiscal policy and the US financial sector but also the international financial system that the chairman of the Fed needs to continually navigate the interfaces of all the institutions that make up this complex universe. Given the colossal amount of economic ignorance on Capitol hill and the presence of loonies like Paul he has an educational and relationship building job to do. This is politics 101 and since Noah is presumably a political science major you have to wonder what he learned at college.