by: Richard A. Anderson, CFA
When Congress passed the Federal Reserve Act in 1913, it established the Federal Reserve System with the initial objective of supporting a fragile banking system. In the over 100 years since it was first established, the responsibilities of the Federal Reserve System (or the Fed for short) have expanded to include several broader responsibilities, such as fostering a sound banking system and a healthy economy. One thing that hasn’t changed is the Fed is an independent government agency that is accountable to the public and Congress to act as the Central Bank of the United States.
Congress sets the Fed’s powers and tasks it with maximizing employment and maintaining stable prices. While Congress ultimately oversees the Fed, Congress gave the Fed the autonomy to carry out its duties without political pressures that could lead to undesirable outcomes. In other words, the Fed operates independently of the federal government.
Fed independence is key for two reasons.
First, the decisions with respect to monetary policy carried out by the Fed are often highly unpopular. Raising interest rates to curb economic growth is rarely met with the approval of the American people. But it’s up to the Fed to take action to prevent inflation and asset bubbles that could be harmful in the longer run. This allows the President and Congress to shield themselves from public scrutiny and deflect blame for a poor economy to the Fed.
Second, the President and members of Congress are elected by the public. Elected politicians tend to focus on the short-term because the short-term performance of the economy is going to drive their chances of getting re-elected. The Fed is tasked with fostering long-term economic growth.
This conflict can sometimes cause disagreements between the President and the Fed. Presidents Truman, Johnson, and Nixon all publicly battled the Fed during their presidencies.
President Trump has very publicly voiced (or tweeted) his displeasure with the decisions of the Fed during his tenure in office. Trump was outspoken in December when the Fed last hiked interest rates, and also critical of the Fed for its most recent decision to cut interest rates. Trump has even threatened to remove or demote Fed Chair Jerome Powell. The law isn’t clear whether the President has this power, but it nonetheless challenges the power of the Fed Chair and undermines the public confidence that the Fed is acting in the best interest of the U.S. economy.
In an op-ed published in the Wall Street Journal last month, former chairs of the board of governors of the Federal Reserve System Paul Volcker, Alan Greenspan, Ben Bernanke, and Janet Yellen emphasized the importance of the Fed acting independently of political pressures to act in the best interests of the economy. The opening paragraph of the op-ed piece reads:
“As former chairs of the board of governors of the Federal Reserve System, we are united in the conviction that the Fed and its chair must be permitted to act independently and in the best interests of the economy, free of short-term political pressures and, in particular, without the threat of removal or demotion of Fed leaders for political reasons.”
The four former Fed chairs did not mention President Trump by name, but it was clear their message was directed towards him.
The sole purpose of the article can be summed up by the closing line of the op-ed, “It is critical to preserve the Federal Reserve’s ability to make decisions based on the best interests of the nation, not the interests of a small group of politicians.”
The Fed, the President, Congress, and the public may not always agree as to the best course of monetary policy action. That’s to be expected. But the Fed’s ability to act independently to serve the long-term best interests of the American people is imperative. Short-term political considerations need to be cast aside in order to promote a healthy economy.
Richard A. Anderson is a portfolio analyst at HIGHLAND Financial Advisors, LLC based out of Wayne, NJ. HIGHLAND Financial Advisors, LLC is a Fee-Only financial planning firm that offers comprehensive financial planning, retirement planning, employer retirement planning, and investment management services to help clients focus on what matters most to them.
Richard graduated from Ramapo College of New Jersey where he earned a Bachelor of Science degree in Business Administration with a concentration in Finance. Richard joined the firm in June 2013 and is responsible for assisting HIGHLAND’s Wealth Advisors in developing portfolios to help individuals, families, and institutions reach their financial goals. He is a Chartered Financial Analyst (CFA) charterholder and member of CFA Society New York. For more of Rich’s thoughts on the markets and sports, follow him on Twitter and connect with him on LinkedIn.