Central Bank Independence Is Not Enough

Four former chairs of the Fed  wrote in the Wall Street Journal today about the importance of Fed independence. I agree, but their article should have emphasized that independence is not enough.  Economic performance has been affected by large shifts between more rules-based and less rules-based policy by the Fed without any concomitant change in the legal basis for independence. De jure independence has not prevented the Fed from harmful departures from rules-based policies.

The absence of a rules-based policy at the Fed in the 1970s was accompanied by high inflation and high unemployment. The move to rules-based policy during the two decades starting in the early 1980s was accompanied by improved price stability and output stability. And a move away from rules-based policy starting around 2003-2005, was followed by poor economic performance including the Great Recession and the Not-So-Great Recovery, as shown in this article in Swedish Riksbank Economic Review

There, of course, have been swings in de facto independence. For example, the Fed sacrificed its de facto independence in the late 1960s and 1970s and regained it in the 1980s and 1990s. There is a close correlation between de facto independence and rules-based policy.

But within a given legal framework, the Fed has engaged in varying degrees of adherence to rules-based policy. We have seen major shifts in the effectiveness of monetary policy within a single framework of central bank independence. Monetary policy needs to focus more on ways to encourage more rules-based policy as well as on ways of maintaining independence.

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