One of the central tenets of the Federal Reserve and most central banks throughout the developed world in the modern era has been their ability to stay above the political fray.
With a few notable (and fairly disastrous) exceptions, the Fed has acted without fear of political retribution from the executive branch, although the Chair still has to testify to Congress and the President periodically.
The assumption of independence, however, has come under fire in recent months. After President-elect Donald Trump floated the conspiracy theory that the Fed was intentionally manipulating interest rates to help President Barack Obama and Hillary Clinton, a hostile Congressional questioning of Chair Janet Yellen in September, and the possibility of Trump packing the Board of Governors with sympathetic members, it no longer is a given that the Fed will be able to maintain its freedom going forward.
In fact, Elga Bartsch, the chief European economist at Morgan Stanley, said in the bank’s outlook for 2017 that one more financial cataclysm could be all that it takes for independence to end.
“Having been overburdened for a long time, many central banks might just be one more economic downturn or financial crisis away from a full-on political backlash,” said Bartsch in a note to clients. “Such a political backlash could call into question one of the long-standing tenets of modern monetary policy making — central bank independence.”
Post-crisis central bank policies have left the financial system potentially vulnerable to a political backlash.
“A prolonged period of exceptionally low interest rates has weighed on financial intermediaries’ business models,” said the Morgan Stanley economist.
“Hence, financial stability issues — ranging from a credit crunch to shortfalls in pension benefits or life insurance payments to a hard landing in risk asset markets (notably housing) — could turn out to be final nail in the coffin of central bank independence.”
Of note, Yellen has recently vigorously defended independence as a key part of the Fed’s work. The two periods of excessive political pressure on the Fed since the end of World War II — immediately after that war and later in the period leading up to the stagflation of the 1970s — ended in negative economic outcomes.
Additionally, how much central bank independence could change depends on the will of the people.
“Whether governments would be able to amend the institutional framework central banks operate under will largely depend on how voters would react to such a proposed change,” concluded Bartsch.
Pew Research’s last annual look into Americans’ opinions of the Fed found that 37% of Americans had an unfavorable view of the central bank while 47% had a favourable opinion, and 16% having no opinion. Interestingly, opinions were also heavily partisan with 48% of Republicans having a negative view, while only 28% of Democrats viewed the bank unfavorably.