Monday, June 01, 2009

Fed independence

Central Bank independence is important for the long term health of any economy. That has been fairly well established. Indeed, in the early 1990s Laurance Summers (and others) argued the importance of Fed independence for keeping inflation in check.

Why? Governments (read politicians) have an incentive to grow the money supply very quickly for short term gains at the expense of longer term inflation. Without the independence it is generally the case that

By Scott Beaulier and William Mounts in the WSJ: Obama Should Reaffirm Fed Independence -
"While understanding the Great Depression is crucial, there is another event in America's monetary history that must be remembered: The 'Accord' of 1951. In this case, Mr. Bernanke should aim to repeat the past.

The accord struck between the Fed and the Treasury in March 1951 fundamentally changed the relationship between the two bodies that had developed during World War II."
and later
"Without a firm commitment by the Obama administration to maintain central-bank independence at all costs, the Fed may become subordinate to the Treasury as it institutes the president's expansive plans to inject government into the economy. If this is the case (to paraphrase Milton Friedman) fiscal deficits will always and everywhere mean inflation."

It should also be noted however that Summers also later wrote that there seemed to be less relationship between Central Bank independence and unemployment rates and other real economic data.

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