President's Message

Amid the many goals of financial and regulatory reform wending their way through Congress, a common theme has recently emerged: curb the independence of the Fed.

The sentiment for such change is understandable. The Fed's actions in financial markets during the financial crisis—lending more than $1.5 trillion to financial institutions, buying $1.25 trillion in mortgage-backed securities—are without precedent. Why should the Fed be free to engage in actions of this scale without the consent of Congress or the U.S. president?

Bullard

James Bullard
President and CEO
Federal Reserve Bank of St. Louis

The answer, as this year's annual report essay makes clear, is that giving the central bank independence is the best method for governments to prevent themselves from printing money for short-term political gain. Governments throughout the world, including our own, have chosen to tie their own hands institutionally to prevent the misuse of monetary policy. Here's why:

Money allows trade to occur more efficiently. Governments have the great power to print money. But printing money to pay for goods is a dangerous temptation with an enormous consequence. When the government prints too much money, the result is hyperinflation and that money becomes worthless. Germany, Hungary, Ecuador, Bolivia, Peru and, most recently, Zimbabwe have been among the casualties of this phenomenon over the previous century.

To avoid such catastrophes and to make themselves credible stewards of their nation's economic interests, most governments have delegated control of their nation's money supply to nonelected officials. By distancing the control of money from politics, they are, in a sense, backing up their pledge to do the right thing.

Such institutional power, however, requires accountability to the electorate. In the United States, the Federal Reserve was given a complicated system of checks and balances to ensure that monetary policy was conducted in a way that protected all interests. In short, the goal is not to make the central bank independent of the democratic process, but to keep it "at arm's length" from partisan politics.

What are these checks and balances? To simplify,

  1. The Federal Reserve is a central banking system. It includes the Board of Governors in Washington, D.C., and 12 regional Reserve banks. This arrangement spreads input into monetary policy decisions around the country, making it more likely that such decisions will be made on economic rather than political grounds.
  2. The 19 Fed policymakers are a balance of political and nonpolitical appointees. The seven members of the Board of Governors are appointed by the president and confirmed by the Senate. The 12 regional Reserve Bank presidents are chosen by a local board of directors, subject to approval by the Board of Governors.
  3. The Fed has budget autonomy from Congress, but must return any income outside of operating expenses over to the U.S. Treasury.
  4. Congress created long terms of office for the Board of Governors (14 years) and staggered the governors' terms. This makes the Board more independent of the political process.
  5. Finally, Congress required the Fed to report regularly on its actions. In return, Congress would not interfere in the Fed's day-to-day-activities.

This year's annual report essay describes in greater detail how and why these arrangements have worked.

As we emerge from one of the worst economic and financial crises in a generation, it is appropriate for the nation to scrutinize the structure and responsibilities of the Federal Reserve System. In a democracy, that's how it's done. But, as the debate ensues about how best to improve the Fed, we should consider change carefully. In creating the Fed, Congress understood that to ensure good monetary policy, the incentives needed to be right. Independence with accountability in the structure of the Federal Reserve System, in my opinion, was the right approach.

James Bullard
President and CEO
Federal Reserve Bank of St. Louis