Question

1. In August 2014, the US banks excess reserves (NBR) were equal to $2.699 trillion while they reached $2.087 trillion in January 2018 due to the historic ending of the Fed’s QE programs.

2. Since January 2009, the monthly average interest rate paid by the Federal Reserve Bank on both required reserve and excess reserve balances has been 25 basis points (0.25%).

3. The federal funds rate (overnight rate) in 2014 was 0.25%, while it was equal to 1.75% in 2018.

4. The Discount Rate in 2014 was 0.75%, while it was 2.25% in 2018.

Question1:

Explain in detail the different arguments for and against the Federal Reserve Bank independence?

Answer 1

The Federal Reserve System is the central bank of the United States of America. Similar to many central banks, the Fed is an independent entity. One of the main reasons that the independence of the bank remains is because it is not funded by the Congress, this does not however mean that they are not accountable to the Congress. There are various arguments both for and against the independence of the Federal Reserve System.

Arguments in favor of the independence of the Federal Reserve System:

1. When the central banks are independent, they are more effective in targetting inflation. Political parties often want to pursue expansionary monetary policies which could lead to inflation and this makes it important to give independence to the central bank. An independent Fed would also keep a check on the debt in the economy as political pressure may force the Fed to monetize the debts.

2. Independent central banks can respond to situations and bring changes in the policies immediately. It was seen that because of the responsiveness of the Fed, the growth of the US economy has been stable since 2009 and the unemployment levels in the economy have reduced as well. Yet another example would be that because of financial unstability, when the Fed bought down the interest rates close to zero, this led to a decrease in the unemployment.

Arguments against the independence of the Federal Reserve System:

1. It would be difficult for the Congress to plan the fiscal policies in accordance with the monetary policies framed by the Fed. There is a need for coordination between the fiscal and monetary policies to achieve the economic targets but since the Fed does not have to get the policies approved by the President, there is a chance that this coordination is lost. It can be seen in the case of the US since 1930s that the central bank's policies were not able to complement fiscal policies, which led to many policy failures.

2. Transparency issues arise when the central bank is given independence, for instance, the Federal Open Market Committee is not audited properly. Such situations can be avoided if there was political interference.