The issue of Federal Reserve Independence, when it comes to monetary policy, once again arose recently, when former President Trump and his running mate argued that the president should have a say in the formulation of monetary policy. They argued that they had unique insights that are more relevant and needed to be considered than those of the FOMC when it comes to policy formulation. Recent research, however, has concluded that when monetary policy is not subservient to political influence economic performance is better1. Kristalina Georgieva indicates that two recent IMF studies, one of dozens of countries between 2007 and 2021and the other of 17 Latin American countries, found that greater independence is associated with lower inflation and better economic growth. While we tend to think that the Federal Reserve is clearly independent, and this was clearly articulated by Chair Powell at his last press conference. But that has not always been the case.
Steven Slavinski, formerly of the Federal Reserve Bank of Richmond, has provided a concise history of Federal Reserve independence, drawing upon the seminal work of Alan Meltzer and other, detailing the evolution of how the Federal Reserve has become an intendent agency when it comes to the formulation and implementation of monetary policy2. When the Federal Reserve was first created in 1913 it was quite tied to the executive branch. Both the Secretary of the Treasury and Comptroller of the Currency sat on the Board and System meetings were actually held in the Treasury. The Reserve Banks are owned by the banks in the respective reserve bank districts and their prime function was to manage an elastic currency, which by statute was backed by gold, that expanded and contracted according the agricultural cycle and need for funds3. Almost from the onset, the System was involved in emergency financing in support of government financing needs. WW1 started in Europe in 1914, and after a brief panic and gold outflows from the US, flows reversed, increasing the money supply, and with it came inflation. US banks and the economy prospered and the ability of the system to discount bankers’ acceptances and to sell government securities both helped to bolster the economy but also facilitated the flow of goods to Europe. When the US joined the war effort in 1917, the system both purchased and sold government debt which not only helped fund the US war effort but also expanded the money supply and lead to an 80% increase in prices between 1916 and 1920. By the end of the 1920s the Fed became concerned about the growth in the stock market and speculation. It increased the discount rate ending the expansion and triggered the Great Depression.
World War II again resulted in the Federal Reserve helping to fund the war effort4. In addition to providing ample financing to banks, the System agreed in July 1942 to peg interest rates on government securities at 3/8s of one percent and that peg lasted through 1947, which meant that the Fed did not and could not engage in discretionary monetary policy. At the same time, the Fed set the discount rate at 1 percent and reserve banks set a preferential discount rate of one-half percent for loans secured by short-term government obligations, which remained in effect through January 1948. The pegged rate on governmental securities was accompanied by a wide range of administrative price controls, including interest rate ceilings established by the Federal Reserve on bank loans.
Following the end of the war, inflation accelerated and in 1947 it peaked at over 20% and in 1948 it was still at 9.5%. As a result, the Fed’s concerns turned from debt finance to inflation. But then the Korean War broke out, which the US entered in June 1950. Inflation was increasing, but Fed attempts to raise interest rates were thwarted by the Treasury because of its war financing needs, and by mid-1951 inflation was at 21%. The need to finance the war and concern about inflation put the Fed in a difficult position which culminated in a meet of the entire FOMC with President Truman concerning the need to maintain the peg on Treasury interest rates. Post meeting there was a disagreement between the White House and Fed as to what was and was not agreed to, with the Fed subsequently asserting that it would no longer maintain the peg. The dispute culminated with an agreement between the Fed and Treasury called the 1951 Accord. The Accord effectively separated fiscal policy, leaving it to the Treasury, and let the FOMC focus on monetary policy and inflation. What we have seen is that over the first 37 years or so of its existence is that Fed was subject to political control and use of its resources to help fund government spending rather than to conduct monetary policy. From a policy perspective the Fed’s focus was on providing an elastic currency and not fighting inflation5.
Post the Accord, three factors were important. First, in part from lessons learned from WWII, monetary policy began to evolve both within the Fed and in the academic community away from providing an elastic currency to controlling interest rates through the discount policy and ultimately to a concern about controlling inflation. Largely through the influence and work of Milton Friedman, the policy focused on controlling the money supply along with using open market operations to influence interest rates as the means to control inflation. Congress played a role in defining specifically the Fed’s objective through its 1977 legislation which established what is now referred to as the Fed’s “dual mandate” to promote stable prices and maximum employment. In reality, the ”dual mandate” is a bit of a misnomer because the act also charged the Fed with a third goal to seek moderate long-term interest rates. But that seems have gotten lost as a policy objective on the part of the Fed. Left undefined in the act was a precise definition of what price stability was or full employment actually were, and those definitions evolved within the System over time.
For example, during his tenure, Chairman Alan Greenspan defined price stability as when businesses and consumers did not have to consider inflation in their decision making, and he studiously avoided providing specific numerical targets when testifying before Congress. Later, the Fed, following many foreign central banks, chose to define price stability as 2% inflation for the Personal Consumption Price index, but left undefined was over what time period was the goal – year over year, monthly, every 6 months? Full employment is viewed as a number reflecting the unemployment rate if the economy was operating at its potential over the longer run.
Second, there have been many instances up to the present time when the Fed has had to come to the support of the federal government through intervention in government securities markets and indirectly to help finance the government. Recent examples include the Great Recession of 2008-2009, in which the Fed reduced the discount rate on bank borrowing, created new bank liquidity programs, provided liquidity support to multiple financial markets, like the commercial paper market and to individual firms. Lastly, the FOMC cut its funds rate target to essentially zero and began a series of Treasury and mortgage-backed-security purchases designed to stimulate the economy and ensure the functioning of financial markets. Despite these efforts, the economy fell into recession but the Fed maintained its continuing support into 2016.
More recently, in response to the COVID-induced recession in 2020 the FOMC again reduced its federal funds rate target to zero. The System also purchased large quantities of government securities and MBS. Fed responded by quickly re-establishing a number of the special purpose lending programs it had used previously during the Great Recess to support financial market with large purchases of MBS and Treasury obligations, and its balance sheet peaked at $7.3 trillion up from $4.2 trillion in January 2020. The actual recession was short-lived and most of the programs were terminated by the end of 2020. Subsequently, to offset the inflation that followed these initiatives the FOMC raised its rate to 5.25%-5.5% where it remains today.
Third, after the Accord, there were continued attempts by the executive branch to influence monetary and interest rate policies, which were sometimes successful. Arthur Burns was appointed Fed chairman by President Nixon with whom he had a long and continued friendship. To accommodate the President, Burns initiated a series of policy accommodations during the 1970s that led to a long period of inflation, which also included Fed administered wage and price controls. Burns view of inflation was that it was caused by a number of economy specific factors which were outside the Fed’s control. The end result became known as the Great Inflation of 1965-1982. It wasn’t until Paul Volcker became chairman did the Fed raise rates leading to the recession of 1980-81. The sharp increases in interest rates engineered by Volcker generated immense pressure from Congress and the president to reduce rates – another example of politically motivate pressure on the Fed.
Presently, as the Fed is facing another round of policies designed to reduce the inflation that came with the efforts to protect the economy from the depressive impacts of COVID, pressure is building on the Fed to begin cutting rates. While we had heard earlier in the year that there was concern that the Fed might cut rates to support a political agenda of one of the parties, that rhetoric has largely disappeared as evidence grows that the economy is slowing and the labor market may not be as strong as previously believed. Chairman Powell strongly rejected the idea at his last press conference that the Fed would bow to political influence or pressure. However, in his very recent Jackson Hole speech, he indicated that now was probably the time to change policy
The bottom seems clear. Independent central banks historically have performed relatively better when it comes to economic growth and maintaining low inflation. But simply granting independence does not mean that attempts to influence policy for political reasons like staying in power or getting reelected will not exist. Maintaining independence requires the right kind of leadership in the central bank, especially when a central bank may sometimes have to take actions during times of economic crisis to support fiscal policies that are also needed.
Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
Email | Bio
1 See IMF Kristalina Georgieva, ”Strengthen Central Bank Independence to Protect the World Economy,” March 21, 2024,
2 Steven Slivinski, “How Monetary Policy and Central Bank Autonomy Came of Age,” 2009, https://fraser.stlouisfed.org/title/econ-focus-federal-reserve-bank-richmond-3941/fall-2009-476946?page=7 and Alan Meltzer, A History of the Federal Reserve, Part I, 2013-1951,
3 Steven Slivinski, “How Monetary Policy and Central Bank Autonomy Came of Age,” 2009, https://frazer.stlouisfed.org/title/econ-focus-federal-reserve-bank-richmond-3941/fall-2009-476946?page=7 and Alan Meltzer, “A History of the Federal Reserve, Part I, 2013-1951,” ucp/books/book/chicago/H/bo3634061.html
4 The Fed engaged in a wide range of activities in support of the war effort. For more details see Gary Richardson, “The Feds Role During WWII,”)
5 This and subsequent discussion relies upon “Overview: The History of the Federal Reserve,”
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