Stan Fischer on central bank independence

Stan Fischer is one of the global elite of macroeconomic policy. Born in what is now Zambia, he has spent most of his adult life in the United States. He was Chief Economist of the World Bank, First Deputy Managing Director of the IMF, Governor of the (central) Bank of Israel, and is now Vice Chairman of the Board of Governors of the Federal Reserve.   He spent several years making a great deal of money at Citigroup in one of those door-opening roles senior officials and politicians often gravitate to.  Fortunately for his reputation, the next big job came up before Citi ran into its latest crisis over 2008/09.

In his time as an academic, Fischer, together with Guy Debelle, came up with the nice delineation between “instrument independence” and “goal independence” in analysing monetary policy arrangements.  In practice, the distinction is never as clean as all that, but one can think of our Reserve Bank having “instrument independence” in monetary policy (it can set the OCR wherever it likes from day to day) but as having relatively little “goal independence”.  The Minister of Finance takes the lead in setting the policy targets and although the Governor is a party to the PTA, the PTA has to be agreed before the Governor is formally appointed.  The Minister does not need to appoint someone who will not agree with his proposed policy targets. And, in principle, the Minister can have the Governor dismissed if the Minister is satisfied that “the performance of the Governor in ensuring that the Bank achieves the policy targets …has been inadequate”.

In many other modern central banks, there is no counterpart to the Policy Targets Agreement, and the statutory objectives for monetary policy are written sufficiently loosely that the central bank has a fairly high degree of goal independence too.   The Federal Reserve  –  where key policymakers rarely even quote the relevant section of the Federal Reserve Act[1] –  is a good example of the latter.

Stan Fischer gave a speech on central bank independence a couple of weeks ago, in which he discussed independence in respect of both monetary policy and (some aspects of) financial stability and regulatory policy.   I thought it was a slightly disappointing, rather complacent, speech.

Part of the context presumably is the simmering discontent with the Fed.  The 2016 Presidential race is getting underway and demand for changes to the Federal Reserve  legislation governing the Fed are being heard –  something that used to be common in New Zealand, but rarely seen elsewhere.

Two issues in particular have prompted legislative initiatives in the United States. One is to limit the Federal Reserve’s operational flexibility in response to financial crises, and the second is the ‘audit the Fed” movement.   I wanted to focus on the audit side.

At present, although the Federal Reserve is subject to regular financial audits, it is exempt from GAO reviews of “deliberations, decisions or actions on monetary policy matters”.   The purpose of the exemption is, supposedly, to protect the day-to-day operational independence of the Federal Reserve  –  the fear, in the words of a Wall St Journal piece, is “that aggressive members of Congress unhappy with a Fed interest-rate decision could dispatch the GAO repeatedly to investigate, essentially using the GAO as a way to pressure the Fed to change its policies.”

I don’t find this resistance overly persuasive.  After all, as Fischer points out, there is lots of external scrutiny and debate around the actions of the Federal Reserve.  Members of the FOMC need to have the fortitude and integrity to make the decisions they think are needed, in accordance with the law, regardless of the weight of external pressure.  If they can’t take the heat, there is always the option of finding another job.  It isn’t clear to me why GAO inquiries, no matter who prompts them, represent a more serious threat.  Either Congress can or can’t overrule the FOMC on specific decisions.  It can’t now, and wouldn’t be able to under any of the legislative initiatives that are around.  Anything else is scrutiny and steps towards effective accountability.

A similar fight is going on in the UK at present, where the Bank of England is fighting back (successfully it appears) against government plans to allow the National Audit Office to undertake value-for-money audits of Bank of England activities (the Court –  the equivalent of our Board –  will be able to block such audits).

Consider, by contrast, the situation in New Zealand.  Not only is the Reserve Bank Board paid to scrutinise and hold to account the Governor, in respect of all his responsibilities (including, quite explicitly, monetary policy), but in New Zealand the Auditor General is (in the Reserve Bank’s own words) “able to commission quite extensive investigations into the activities of the Bank”

And then there is section 167 of the Reserve Bank Act, which explicitly provides the Minister of Finance with powers to commission a performance audit of any or all aspects of the Bank’s responsibilities under the Reserve Bank Act [but not, it appears, those under the other Acts the Reserve Bank is responsible for?]

167 Performance audit

  • (1) The Minister may, from time to time, appoint 1 or more persons (whether as individuals or as members from time to time of any firm or firms) to carry out an assessment of the performance by the Bank of its functions and of the exercise by the Bank of its powers under this Act.

    (2) As soon as practicable after completing an assessment the person appointed shall submit a report to the Minister setting out the results of that assessment.

    (3) The report stands referred, by virtue of this section, to the House of Representatives.

    (4) A person appointed to conduct an assessment under this section, for the purpose of conducting that assessment,—

    • (a) shall have full access to all books and documents that are the property of or that are under the control of any person relating to the Bank or its affairs:

    • (b) may require any director, officer or employee of the Bank or any other person to answer any question relating to the Bank or its affairs:

    • (c) may, by notice in writing to any person, require that person to deliver any books or documents relating to the Bank or its affairs in the possession or under the control of that person and may take copies of them or extracts from them.

    (5) Nothing in subsection (4) limits or affects section 105.

    (6) The fees of the person appointed to carry out an assessment under this section shall be paid out of the funds of the Bank.


Of course, the section 167 powers have not been used in the 26 years since the Act was passed (although Lars Svensson’s inquiry into New Zealand monetary policy, commissioned by Michael Cullen, might be seen in that light)

And yet the best argument that Fischer can put up in response is that if such further audit or review powers were established

“the Fed would be subjected to the very sort of political pressure from which experience suggests central banks should be independent. Instead, a modern governance framework calls for the political system to give the central bank a mandate along with the operational freedom to pursue that mandate, supported by transparency and accountability”

Central banks are very keen to conflate the ideas of transparency and accountability – the Reserve Bank did it recently in their Bulletin on monetary policy accountability – but apply the parallel to an employee. Effective accountabiity for an employee rests on the simple fact that, after all the discussion and debate, if the employee does not work to the required standard he or she can be dismissed.

Members of the Federal Reserve Board cannot be removed from office for their policy choices, no matter how bad they might be. That is not uncommon for central bankers internationally, but it severely compromises the meaning of accountability. Central bankers don’t face re-election either. Reappointment is certainly one opportunity for effective discipline, but in principle members of the Federal Reserve Board of Governors are appointed for 14 year terms.

If Fischer is serious about maintaining a distinction between instrument independence and goal independence in the United States it is not clear why he would not support a move more towards a New Zealand system, where policymakers can be removed if they make bad policy. But if that can’t be practically be done – and perhaps it can’t in a US system, and perhaps it isn’t a practical option even here – it is far from clear why he (and his colleagues would continue to push back against measures that would provide for more official scrutiny of the choices and actions of the Federal Reserve. It is all very well to say that markets, the media, and think tanks scrutinise the Fed, but statutory provisions bring with them statutory powers, including access to relevant papers and information. I’m not suggesting that the Rand Paul “audit the Fed” bill has things precisely right,   But as Vincent Reinhart, a former very senior Fed monetary policy official, has argued, what possible threat could a twice-yearly “GAO audit of monetary policy:, a week before the Fed’s own semi-annual monetary policy report to Congress”, be?

Of course, one could reasonably counter “what good would it do”? But that is surely a matter for Congress, as the people’s representative, not for those who are being reviewed. Central banks are given very great power and it is up to us, as citizens, to find ways to effectively hold them to account. That has to include the ability to put pressure on them, even if the day to day decisions are finally theirs.

The New Zealand model has not worked particularly well in that regard – the Board is just too close to the Governor, and Parliament’s Finance and Expenditure Committee has too few resources and incentives. But equally, one can hardly say that the powers that do exist – which go well beyond those in the US – have threatened the operational independence of the Reserve Bank, on monetary policy or any of its other functions.

But surely the practical problem for citizens is the difficulty of securing effective accountability. There is plenty of debate about what central banks do – at least in the US – but accountability is more than debate, and has to include the ability to make a practical difference.

There is a price for operational independence. If legislatures do not think that those wielding the operationally independent powers are doing so appropriately, on  average over time, and yet cannot effectively hold decision-makers to account for their choices, operational independence itself will come under threat.  In a sense, that is what the Warren-Vitter legislative initiative (which the Fed is also fighting) seeks to do in the United States, in further restricting the Fed’s freedom of action in a crisis.   As I’ve noted previously, the US authorities (Treasury and the Fed) already have far less operational autonomy in a crisis that the New Zealand authorities do. In some respects, the New Zealand powers are disconcertingly wide –  the Public Finance Act appears to allow the Minister of Finance to bankrupt New Zealand with no parliamentary vote, and the Reserve Bank also has uncomfortably unconstrained powers in these areas. I suspect that something between the two models provides a better balance, but at least we have formal powers to review, and potentially dismiss, the Governor if he acts unwisely or inconsistently with his statutory mandate.  The US system has no such power.    If anything, it looks to me as though the Fed –  were it operating consistently with the goal vs operational independence model –  should be embracing as many reviews, and as much official scrutiny, as possible.

But perhaps that is the problem with global elites, in macro policy or other areas.  They often don’t really believe in effective accountability to citiznes, or in their potential for making mistakes.  They believe, too readily, in the rightness of their own judgements.  Institutional design has to operate with the limits of human knowledge and incentives. Humans –  even very able ones – and human institutions make mistakes.  And yet in the whole of Fischer’s speech, the words “error”, “mistake” and “misjudgement” don’t appear once.  Good models for governing powerful institutions have to built, and refined, starting from the proposition that people like Stanley Fischer, Ben Bernanke , and even Graeme Wheeler, will actually make mistakes.

[1]The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”