Why Is the Federal Reserve Independent? (2024)

Many people are surprised to learn that the central bank of the United States, the Federal Reserve ("the Fed," for short), operates for the most part independently of the federal government. But the Fed is also a quasi-governmental agency with a board of governors selected by the President and approved by Congress. The combined public and private structure of the Federal Reserve remains highly controversial, especially in the aftermath of the financial crisis of 2007–2008.

The role of the Fed as the central bank in the U.S. and its position of influence highlights the question of whether or not central banks should be independent from the political bias of government.

Key Takeaways

  • Central bank independence refers to the question of whether the overseers of monetary policy be completely disconnected from the realm of government.
  • Those favoring independence recognize the influence of politics in promoting monetary policy that can favor re-election in the near term but cause lasting economic damage down the road.
  • Critics of independence say that the central bank and government must be tightly coordinated in their economic policy.
  • These critics also argue that central banks must have a high degree of regulatory oversight.
  • In reality, central banks, including the Fed, are granted a good degree of independence but are still somewhat beholden to the government.

The Fed as Quasi-Governmental

The independence of America's central bank has always been a contentious issue. In the early days of the Republic, the founding fathers ultimately opted against having a central monetary authority. Although Alexander Hamilton was successful at establishing the Bank of the United States for several years, it ultimately failed. It was not until the Federal Reserve Act of 1913 that established the present-day central bank.

Prior to the Fed, recessions and financial panics were commonplace as investors and depositors could not be sure of the stability and solvency of the banking system. Indeed, private financiers like J.P. Morgan had to bail out the American banking system in 1895 in the absence of a central bank to act as lender of last resort. The Federal Reserve Act sought to bring stability to the financial sector and centralize monetary policy under a single authority.

The monetary decisions of the Federal Reserve are meant to be separate from the government, and policy moves do not have to be ratified by the President, or anyone else in the Executive Branch.The Fed receives no direct funding from Congress, and the members of the Board of Governors, who are appointed, serve 14-year terms. These terms do not coincide with presidential terms, creating additional independence.

However, the Federal Reserve is subject to some oversight by Congress, which aims to ensure it achieves the economic objectives of maximum employment and stable prices.In addition, the Fed Chair must submit a semi-annual report on monetary policy to Congress.

The Federal Reserve does not receive funding through the congressional budgetary process. The Fed's income comes primarily from the interest on government securities that it has acquired through open market operations. After paying its expenses, the Federal Reserve turns the rest of its earnings over to the U.S. Treasury.

Why Be Independent?

The primary justification for an independent Federal Reserve is that it's necessary to insulate system from short-term political pressures.Without a degree of autonomy, the Fed could be influenced by election-focused politicians. For example, it could be pressured into enacting an excessively expansionary monetary policy to lower unemployment in the short term, which may later lead to high inflation and fail to control unemployment over the long term.

Indeed, proponents of central bank independence argue that political pressure is too great to let it interfere with monetary policy and macroeconomic decision-making. In particular, politicians have short-term goals of re-election, which tend to favor inflationary policies that give the illusion of boosting wages and employment, but at the expense of longer-term growth. Furthermore, inflation can undermine the purchasing power of currency and harm creditors and savers.

Advocates of autonomy thus argue that an independent Fed can better address long-term economic objectives. Independence can also make it easier to execute policies that are politically unpopular but serve a greater public interest. Another argument is that the central bank should be filled with economists and other experts, rather than politicians or those under political sway.

The U.S. Congress has established full employment and stable prices as the key macroeconomic objectives for the Federal Reserve in its conduct of monetary policy.

Arguments Against Independence

Critics argue that it is unconstitutional for Congress to assign monetary power to an independent quasi-governmental agency. According to the Constitution, Congress has the power to coin money and regulate its value. In 1913, Congress delegated this power to the Fed through the 1913 Federal Reserve Act. However, some argue that such a delegation is fundamentally unconstitutional.Opponents of the Fed's independence also suggest that it is undemocratic to have an unelected agency, unaccountable to the US public, dictating monetary policy.

Another argument against independence is that it fosters poor coordination between the fiscal policy put in place by Congress—including taxation and spending—and the monetary policy enacted by central banks. For instance, if the government is cutting taxes (loose fiscal policy), but the central bank is raising interest rates (tight monetary policy), this can create a mismatch that undermines both's efforts.

How Is the Federal Reserve Independent?

The Fed is independent in the sense that monetary policy and related decisions are made autonomously and are not subject to approval by the federal government. However, its governors are appointed by the President and must be confirmed by Congress. Moreover, there is some congressional oversight and the Fed must work within the framework of the government's overall economic and fiscal policy objectives.

Who Does the Federal Reserve Lend to?

As a central bank, the Federal Reserve lends money to commercial banks that make up the American banking sector. This is done to address temporary problems they may have in obtaining funding or to meet reserve requirements, and the loans are for very short durations. To minimize the risk that the Federal Reserve will incur losses from lending, borrowers must pledge collateral, such as loans and securities. Since 1913 when the Federal Reserve was established, it has never lost a cent on its discount window loans to banks.

Where Are the 12 Regional Federal Banks?

The Federal Reserve System (FRS) is composed of twelve regional branches. The system's 12 regionalFederal Banksare based in Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco.

The Bottom Line

The Federal Reserve occupies a unique role, operating both independently of the federal government while still being subject to some oversight. The agency is governed by a board whose members are selected by the President and approved by Congress. However, the Fed is also independent in the sense that it conducts monetary policy and related decision-making autonomously. Because of its quasi-governmental status, the Fed has faced critism from some who argue that it's unconstitutional for monetary policy to be designated to an unelected agency, unaccountable to the public. On the other hand, there are many who argue that the Fed's independence is critical to its ability to set long term monetary policy outside the influence of short-term politcs.

Why Is the Federal Reserve Independent? (2024)

FAQs

Why Is the Federal Reserve Independent? ›

Congress has determined the Federal Reserve can best achieve its mission of supporting maximum employment and stable prices as an independent agency that makes decisions based on the best available evidence and analysis, without taking politics into consideration.

Is the Federal Reserve independent from the government? ›

The Federal Reserve occupies a unique role, operating both independently of the federal government while still being subject to some oversight. The agency is governed by a board whose members are selected by the President and approved by Congress.

Why is the Federal Reserve independent quizlet? ›

The Fed is politically independent since the monetary decisions of the the Fed do not have to be ratified by the President or anyone in the Executive Branch. The Fed does not receive funding from Congress and the Board of Governors serve 14-year terms, which do not coincide with presidential terms.

How politicized is the Federal Reserve? ›

The Federal Reserve is not immune to political pressure (Binder & Spindel, 2019). Indeed, it is less independent than most other central banks.

Who controls the Federal Reserve? ›

The Board of Governors--located in Washington, D.C.--is the governing body of the Federal Reserve System. It is run by seven members, or "governors," who are nominated by the President of the United States and confirmed in their positions by the U.S. Senate.

When did Federal Reserve become independent? ›

The Fed was forced to freeze its asset portfolio and the monetary base was effectively determined by the Treasury. Although the Fed Board of Governors moved into their own building in 1937, their independence in monetary policy wasn't established until 1951.

Who owns the 12 banks of the Federal Reserve? ›

Federal Reserve Banks' stock is owned by banks, never by individuals. Federal law requires national banks to be members of the Federal Reserve System and to own a specified amount of the stock of the Reserve Bank in the Federal Reserve district where they are located.

Why is the Federal Reserve so controversial? ›

Critics have also raised concerns about the Fed's role in fractional reserve banking, its contribution to economic cycles, and its transparency. The Fed has been accused of causing economic downturns, including the 2007-2008 financial crisis, and of being influenced by private interests.

What is an argument against the Federal Reserve independence? ›

Question: An argument against Federal Reserve independence is thatindependent central banks produce lower inflation. central bank officials are not elected. central banks are immune from political pressures that would result in inflation. Congress chose to delegate monetary authority to the Fed.

What would happen without the Federal Reserve? ›

If it was abolished it would collapse the entire global capitalist system. Capitalism needs the fed to control the chaos of the system. Then we go back to the situation before the Federal Reserve was adopted - Wall Street Banks become the de facto central bank of the United States.

Can the president fire the chairman of the Federal Reserve? ›

The president may not have the legal authority to dismiss a chairman before the end of a term, although this assumption has never been tested in court. The current chairman is Jerome Powell, who was sworn in on February 5, 2018.

How much power does the president have over the Federal Reserve? ›

The president can appoint and fire the Federal Reserve chair

According to the Federal Reserve Act, the chair and vice chair of the board are appointed by the president but must be confirmed by the Senate. Fed chairs and vice chairs serve four-year terms and can be reappointed by the sitting president.

Do we need the Federal Reserve? ›

The Federal Reserve monitors financial system risks and engages at home and abroad to help ensure the system supports a healthy economy for U.S. households, communities, and businesses.

Who are the 7 members who run the Federal Reserve? ›

Current members
Current governorPartyTerm expires
Jay Powell (Chair)RepublicanJanuary 31, 2028 (as Governor)
Philip Jefferson (Vice Chair)DemocraticSeptember 7, 2027 (as Vice Chair)
January 31, 2036 (as Governor)
Michael Barr (Vice Chair for Supervision)DemocraticJuly 13, 2026 (as Vice Chair for Supervision)
6 more rows

Why did U.S. lawmakers create the Federal Reserve? ›

A particularly severe panic in 1907 resulted in bank runs that wreaked havoc on the fragile banking system and ultimately led Congress in 1913 to write the Federal Reserve Act. The Federal Reserve System was initially created to address these banking panics.

What is the major asset of the Federal Reserve? ›

Treasurys and other securities, on the other hand, are considered assets. Securities held outright make up about 94 percent of the Fed's total balance sheet. Nearly two-thirds are Treasury securities, including shorter-term Treasury bills, notes and bonds. Mortgage-backed securities make up another almost one-third.

Are Federal Reserve bank employees government employees? ›

No. Federal Reserve Bank employees are not government employees; however, Board of Governors employees are considered government employees. Each Reserve Bank determines its own benefits and human resources policies, and employees are paid as part of the expenses of their employing Bank.

How is the Fed accountable to Congress? ›

In the area of monetary policy, twice a year, the Federal Reserve submits an extensive report--the Monetary Policy Report--on recent economic developments and its plans for monetary policy. In addition, the Chair and other Federal Reserve officials often testify before the Congress.

What would happen if the Federal Reserve did not exist? ›

What would happen if we get rid of the Federal Reserve? Then the largest commercial banks in the country would effectively be in charge of the money supply of the United States. That was the status quo before the Fed was created. That turned out to be a really bad idea.

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