Fed's Independence Under Fire as Political Pressures Mount

In the realm of economic policy, the independence of the Federal Reserve has long been a contentious issue. The historical context reveals that the Fed's independence has been a delicate balance, often swayed by political pressures. Nixon's words to Fed Chair Arthur Burns in 1970, "I respect his independence... I hope that independently he will conclude that my views are the ones that should be followed," set a precedent for the Fed's subservience to political goals. Burns' tenure was marked by inflation, a direct result of his compliance with Nixon's wishes.

Subsequent Fed chairs have striven to maintain the Fed's independence, with Jerome Powell recently asserting that the Fed is an independent agency within the government. Powell emphasized that individual members of the Federal Open Market Committee (FOMC) are insulated from politics due to their long terms and the requirement that they can only be removed for cause. This, he argued, allows the FOMC to operate without political influence.

However, the Fed's independence is not absolute. The Fed was established by an Act of Congress, which retains the power to revise the Act if it disapproves of the Fed's operations. This was evident when Ben Bernanke, in his final press conference as Fed chair, advised his successor, Janet Yellen, that "Congress is our boss." The Fed's independence is thus contingent on political approval, and Congress has generally held the Fed accountable only after financial disasters, often granting it more power in response.

The interdependence between the Fed and Congress is a well-documented phenomenon. The Fed relies on Congress for its authority, while Congress depends on the Fed for economic stewardship. This arrangement allows Congress to blame the Fed when things go wrong, making the Fed acutely sensitive to securing political support for its policy choices. Monetary economist James Dorn found that the Fed's independence is continuously tested by political pressures for accommodative monetary policy and credit allocation to win votes.

Presidents have historically exerted significant pressure on the Fed. Truman called William Martin a "traitor," LBJ verbally assaulted Martin over interest rates, and Burns was subservient to Nixon. Carter reassigned William Miller to the Treasury Department due to low interest rates, while Volcker's ability to raise rates to 20% was backed by Reagan. Thomas Drechsel's study found that political pressure increases inflation strongly and persistently, with a half increase in pressure raising the price level by more than 8% after a decade. This pressure also negatively affects GDP, though mildly.

Recent events have raised concerns about the Fed's independence. Publicly calling Chair Powell a "major loser" has been seen as a form of political pressure, reminiscent of Nixon's tactics. This pressure could potentially lead to increased inflation and economic instability. Markets have reacted to this pressure, with Bitcoin ETFs taking in significant investments, indicating a sense of uncertainty and a potential fight for the Fed's independence in the coming decade.