Fed independence is the worst solution except for all the others

THERE’S cause to question the Fed's policies lately. The so-called “Greenspan put” and loose monetary policy may have fueled the financial crisis. More recently, the second round of quantitative easing has divided economists. Some say it’s the only way to prevent harmful deflation. On the other hand, it may spark asset bubbles abroad and rampant inflation in America. It’s not surprising that the Fed's independence has become so unpopular. We may hear more Fed scepticism now that Ron Paul, not a Fed fan, is chairman of the subcommittee that oversees it. He favours more congressional oversight. But subjecting monetary policy to the political process would be a mistake. An independent monetary authority makes fiscal policy possible because it gives the Treasury the ability to issue cheap debt.  It is too easy for politicians to use monetary policy to inflate away debt. Independent monetary policy provides credibility to the bond market that this will not happen, keeping rates low. Ask two economists about pretty much anything and you’re guaranteed to get two different answers. But there exists one common enemy: politicians (though most economists reluctantly agree that politics is a necessary evil). A dictatorship tends to cause more trouble than even the most dysfunctional democracy. The challenge is how to have swift, thoughtful policy, which may hurt in the short run, and accountability. Central bank independence, while imperfect, is the best solution we have.The disagreement between Republicans and Democrats about tax cuts for the wealthy demonstrates how the political process undermines good economics. It has less to do with economics than it does with baseless ideology (on both sides) and political grandstanding. To be fair, the incentives of even the most civic minded and thoughtful politician often clash with sound economic policy. Good economic policy weighs the long- versus the short-term and recognises the limited ability of the government to improve economic fundamentals. That’s a tough platform, especially when you must get re-elected every few years. The inherent conflict between the short-term demands of politics and long-term good of the economy is a primary justification for Fed (or monetary policy) independence. The Fed can not fulfill its mandate of reasonably low, predictable inflation and unemployment while satisfying the short-term whims of politicians and the electorate.read more