The Federal Reserve: An Integral Part of the US Government
The US Federal Reserve has been successful in promoting the perception that it is independent and separate from the US government that established it. This alleged autonomy of the Fed is often taken as a given by economists and media commentators. They suggest a clear divide between the executive branch and the central bank. Some even go to the extent of suggesting that the Fed is in conflict with the government or only answers to bankers without considering the government's agenda.
Reality of the Federal Reserve's Independence
While it's true that senior technocrats at the Fed may not always agree with the priorities of Congress or the White House, this doesn't necessarily mean the Fed is independent. Bureaucrats generally prefer to operate without needing approval from higher-ups, and Fed personnel are no different from senior technocrats at any executive-branch department. However, historical evidence shows that the Federal Reserve has repeatedly aligned its policies with those of the Treasury and the administration to ensure the federal government gets what it wants from the central bank.
The Federal Reserve during the Great Depression and World War II
During the Great Depression and World War II, for example, the executive branch under Franklin Roosevelt overtly managed the Federal Reserve, requiring close cooperation between the Fed and the White House. The Fed tried to gain more autonomy during this period, but these efforts were curtailed by the onset of World War II. The Fed was used as a mechanism for the government to finance the war effort more cheaply.
The Federal Reserve in the 1950s and Beyond
In the 1950s, the relationship between the Fed and the rest of the executive branch was explicit in legislation. However, the Fed tried to gain more independence during the Korean War. But the demands of Cold War spending and new welfare programs quickly revealed the true nature of the relationship.
The Great Inflation and the 1970s
As federal spending accelerated during the 1960s, the Treasury increasingly relied on the Fed to facilitate larger deficits without allowing Treasury yields to rise. This policy of "coordination" led to the Great Inflation of the late 1960s and the 1970s.
The Plaza Accords: Volcker and the Weakening of the Dollar
By the early 1980s, price inflation had become a significant political problem, forcing the Reagan administration to request that the Fed abandon its usual policy of suppressing borrowing costs for the Treasury. However, this change in monetary policy led to a stronger dollar, which made American exports more expensive and increased the trade deficit. As a result, special interest groups began demanding a weaker dollar.
The Federal Reserve after the 2008 Financial Crisis
Since the 2008 financial crisis, the Fed's willingness to coordinate with the Treasury and Congress has become even more apparent. Deficits increased, and the federal debt rose by more than five trillion dollars from 2008 to 2011. The Fed bought up trillions of dollars of Treasurys to reduce federal borrowing costs and embraced zero-interest rate policy for eight years.
Bottom Line
Given this history of facilitating the federal government's massive debts and unchecked spending, it's challenging to see where the famed "Fed independence" fits in. An honest look at Fed interventions suggests that the Fed never refuses to facilitate the federal executive branch in implementing its political program.
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