Fed Independence and Inflation

The Eccles Building (wikimedia)

The Eccles Building (wikimedia)

Making the case for Central Bank independence, Megan McArdle says:

So there is something magical about bank independence. It lets Congress cut against its basically populist political interests. You may think that makes it too bank-friendly. But it also means we don’t have double-digit inflation, which is where we were headed before Volcker.

But of course the Fed had its statutory independence before Volcker. And yet inflation went from “a bit high” in the late sixties to “out of control” in the seventies precisely because the Fed was making monetary policy in the early 1970s with an eye toward ensuring Richard Nixon’s re-election in 1972. Nothing about Fed “independence” actually prevented the very politicization of monetary policy that it’s supposed to prevent. And by somewhat the same token, I think there’s some reason to believe that Alan Greenspan kept monetary policy so loose in 2004 precisely because, given his belief that tax cuts for rich people and dismantling Social Security benefits for old people constituted a sure path toward prosperity, he wanted to help George W. Bush’s re-election campaign.

Which isn’t to say that having Congress set monetary policy would be better. A point Megan makes earlier in the post is that Congress pretty clearly doesn’t actually want to set monetary policy. But that’s about what Fed independence consists of, the fact that key political actors would rather distance themselves from monetary policy decisions than have the power to make them. Nothing’s actually stopping Congress from making the Fed do what it wants, and Fed decisions and Presidential politics are inextricably intertwined. What wards off inflation probably isn’t procedural rules, it’s the existence of a pretty firm political consensus against inflation. At times in American history we’ve had explicit pro-inflation political movements; if we had another one today, the Fed would probably start to look different.