ECON102: Principles of Macroeconomics (2021.A.01)

The institutional relationship between the leaders of the Fed and the executive and legislative branches of the federal government is structured to provide for the Fed's independence. Members of the Board of Governors are appointed by the president, with confirmation by the Senate, but the 14-year terms of office provide a considerable degree of insulation from political pressure. A president exercises greater influence in the choice of the chairman of the Board of Governors; that appointment carries a four-year term. Neither the president nor Congress has any direct say over the selection of the presidents of Federal Reserve district banks. They are chosen by their individual boards of directors with the approval of the Board of Governors.

The degree of independence that central banks around the world have varies. A central bank is considered to be more independent if it is insulated from the government by such factors as longer term appointments of its governors and fewer requirements to finance government budget deficits. Studies in the 1980s and early 1990s showed that, in general, greater central bank independence was associated with lower average inflation and that there was no systematic relationship between central bank independence and other indicators of economic performance, such as real GDP growth or unemployment.See, for example, Alberto Alesina and Lawrence H. Summers, "Central Bank Independence and Macroeconomic Performance: Some Comparative Evidence,". By the rankings used in those studies, the Fed was considered quite independent, second only to Switzerland and the German Bundesbank at the time. Perhaps as a result of such findings, a number of countries have granted greater independence to their central banks in the last decade. The charter for the European Central Bank, which began operations in 1998, was modeled on that of the German Bundesbank. Its charter states explicitly that its primary objective is to maintain price stability. Also, since 1998, central bank independence has increased in the United Kingdom, Canada, Japan, and New Zealand.

While the Fed is formally insulated from the political process, the men and women who serve on the Board of Governors and the FOMC are human beings. They are not immune to the pressures that can be placed on them by members of Congress and by the president. The chairman of the Board of Governors meets regularly with the president and the executive staff and also reports to and meets with congressional committees that deal with economic matters.

The Fed was created by the Congress; its charter could be altered - or even revoked - by that same body. The Fed is in the somewhat paradoxical situation of having to cooperate with the legislative and executive branches in order to preserve its independence.