Question

In what way does the Federal Reserve have a high degree of instrument independence? If it has a specific dual mandate from Congress to achieve “maximum employment and low, stable prices”, then how does it have goal independence?

Answer 1

The Federal Reserve System in U S operates independently from unwanted government intervention.

The monetary policy of the Federal Reserve (FR) do not to be checked and ratified by any of the members in ministry. The Federal Reserve does not acquire and finance from the parliament. As such it is free to use its own funds in a judicial manner. The duration of the office of the members of the Board of Governors is 14 years. Their term does not coincide with any of the member’s term in congress. This ensures more independency in the working of the Federal System.

If the Federal Reserve is free from any kind of political pressure it will be a better agency to achieve long term objectives in the public interest.

As per the provisions in the constitution the congress has the power to coin money and regulate it. But in 1913, the delegated its power to Federal Reserve by Federal Reserve Act. This gives full autonomous power to Federal Reserve which is strong method to achieve full employment and price stability.

But the Federal Reserve is subjected to supervision by the congress with the objective of maximum employment and stable prices. The Chairman of the Federal Reserve to submit a semi-annual report on monetary policy to the parliament.

The Federal Reserve is not absolutely free from political pressure. The Federal Reserve may be influenced by politician in short term to expand its monetary policy to generate more employment. This may lead to high inflation and fail to control employment in long term.

But the recent call from the government to increased finance to American International Groups lead to the demand for increased transparency in the working of the Federal Reserve. Again the recent call to audit the Federal Reserve may probably undermine the independents nature of the Federal Reserve.

But it is very important that the Federal Reserve to be independent because much of their open market operations tend to be very politically influenced which may considerably effect the economic objectives of the country such as full employment and price stability. Its charter to be revoked so as to ensure maximum independency.

Federal Reserve is the prime regulator of banking industry. It is headed by collection of economist and bankers who decide the levels at which banks and public borrow. It must have more discretionary power to decide the rate of interest and granting of loans.

The Federal Reserve is an independent agency but it is ultimately accountable for public and congress. It is the congress which determined the rate of maximum employment and price level in its conduct of monetary policy. The congress has structure the Federal Reserve to ensure its monetary policy decisions to achieve the long term objectives and shall not be a subject of political pressure.

The Fed is not functioning with the budget of the congress. Its income primarily comes from the interest on government securities that it has acquired from open market operations. Apart from it the Federal Reserve receives income in the form of interest of foreign currency investment, fees received for service provided to depository institutions, automated clearing house operations and interest on loans to depository institutions.

From the above points we can conclude that the Federal System is partially independent.

But the full independency of the Federal Reserve is very important. The reason is that controlling inflation is a vital important. But very often the Federal Reserve is subjected to political pressure to increase money supply for increasing employment during short run. This produce higher inflation and higher interest rate without lowering the unemployment in long run. Experience of many countries shows the same effect.

The politicians manipulate money supply during election, the output grows to peak during election but falls for ever.

The politicians increase government debt which creates inflation. When the government purchases goods and services, these purchased must be finance by rising taxes, borrowing from the public or printing notes. If the government spending is much larger than taxes then the deficit must be financed by printing money or issuing new government debt in the form of selling securities. But the increased debt is finance by the printing of currency and this will lead to inflation.

Thus to conclude the Federal Reserve must be fully free from political influence so that the prime object of the economy like full employment with price stability can be achieved