Is the Fed’s Independence in Danger?

First we might ask whether framing the question this way betrays a subtle bias.  Is the Fed independent?  Or is it unaccountable?  The choice of words implies a value judgment that begs for thoughtful deliberation itself.  But the virtually uniform habit of the financial media of using the term independence forecloses any such deliberation; it has already been determined that it’s a good thing.  The very word independence connotes a positive spin.  The media could just as easily call it unaccountability and condem it from the get go.  Here at Financology we relish digging into questions whose answers are taken for granted.  It often turns out that the most important questions are those that are not asked.

Certainly the Fed answers to somebody or something.  The official something is the dual mandate imposed by Congress in the form of Humphrey Hawkins.  The Fed is charged with the pursuit of maximum employment and price stability.  But that allows a lot of discretion.  In 2012 it decided to define price stability as a 2% rate of inflation, and further named its preferred measure of inflation the so called “core” personal consumption expenditures deflator.  As far as I know, the people of the United States were not consulted, either directly or through any of their elected representatives.

None of this is to imply we should prefer direct political control over interest rates or the money supply.  How many politicians would press for tighter money?  That doesn’t seem to be President Trump’s agenda.  So if anything the Fed appears to be raising rates into a political headwind, implying that it is leaning more toward the politically difficult than the politically easy.  It wants to normalize interest rate policy after nearly a decade of ultra low rates.  But why did it wait so long?  If were concerned about too low inflation, there was more than one way it could have had higher inflation.  For one, it could have chosen a less arbitrary target, like 0%.  Or it could chosen a less narrow way to measure it.  Domestic consumption prices are but a small slice of dollar denominated transactions.  It could have found much higher inflation, for example, by including asset prices in its reckoning.  US stock prices for instance have inflated by more than a factor of four just since March 2009.  This may not be a hardship for folks who want to sell their stocks, but it sure is for those who are buying them for future education or retirement goals.  For every seller that benefits from higher prices, there is a buyer who benefits from lower prices.  Those who already owned stocks benefit at the expense of those who didn’t.  This is no accident; former Fed chair Ben Bernanke expressly cited increasing asset prices as a goal.  So this is clearly an act of choosing winners and losers.  The owners of most of the assets, by definition the wealthy, won at the expense of those who own relatively little.  Is exploding the wealth gap part of the Fed’s mandate?

As noted before, this is not an argument for political control over the Fed.  But it sure hasn’t been behaving in a way that supports its claim to independence.