Fed Sacrificing Independence to Avoid “Perceived Loss of Independence”

Via Felix Salmon, some troubling reporting from Greg Ip about the Fed’s quantitiative easing programs:

If the programmes are doing some good, why is the Fed not expanding them? The outlook has improved, for one thing: America’s economy is levelling out, it noted on August 12th. But the main reason is political, not economic. The Fed’s Treasury-purchase plan prompted charges that it was inviting hyperinflation and had subordinated itself to the government’s deficit needs. Alan Greenspan, a former Fed chairman, says inflation will exceed 10% if the Fed fails to shrink its balance-sheet and raise rates, and 3% for a time even if it does.

Needless to say, that is not the Fed’s view: it still foresees rising unemployment and falling inflation. But many officials have concluded that, for now, the benefits of buying more Treasuries do not outweigh the costs of a damaging rise in inflation expectations and a perceived loss of independence.

The point of central bank independence, of course, is precisely to avoid making decisions such that “the main reason is political, not economic.” When that starts happening, something’s gone wrong. And it seems to me that something’s gone doubly wrong when decisions are being made for political reasons not because other elements of the government are infringing on the Fed’s independence, but because Fed decision-makers feel that they should take a specific wrong-on-the-merits course of action in order to avoid “a perceived loss of independence.” After all, now they’ve lost the real thing!

Salmon tries to cash this out in a way such that it might make sense:

I think that what Ip is trying to say is that central banks have a lot of independence so long as inflation expectations are low, but if they’re perceived to have lost their grip on inflation, then that perceived independence can evaporate very quickly. (This is all about perceptions, interestingly enough: inflation expectations, rather than actual inflation and perceived independence, rather than actual independence.) And so in order to maintain a reputation for independence, they will be inclined to favor the arguments of political hawks. It’s a way of second-guessing themselves into having less independence in reality, just for the sake of keeping more independence in the public mind. Or something.

“Or something,” indeed. The fact of the matter is that too much attention to perceptions undermines independence, and undermining your independence is bound to lead to the perception that your independence has been undermined.