CAN CENTRAL BANKS EVER BE INDEPENDENT?

Can Central banks ever be independent?

Can Central banks ever be independent?

In recent months, the central banks of G-7 group have come together more than once to come up with a joint strategy to bring out their respective economies and with them the world out of the worst economic crisis to hit the global financial system since the Great Depression of 1930's. The last of these measures took place two weeks ago, when the “Bank of England (BoE), the European Central Bank (ECB), the Federal Reserve, the Bank of Japan, and the Swiss National Bank (SNB) jointly announced further measures to improve liquidity in short-term U.S. dollar funding markets”(Fed Press Release Oct.13 '08) (Laurence 2001).

While all the central banks, even those out of the sphere of G-7, are busy coordinating their efforts to better deal with the situation- question arises on the importance of central bank independence in dealing with the current financial crisis. This paper, while being brief, will primarily look into the independence of Federal Reserve (Fed) of USA and its ability to maneuver in the current situation. This topic will be the first of the many that will be provided to you by the academic committee in the coming weeks, as I will try to lay the base to discuss the role of central banks and importance of central bank independence for an effective financial system to operate in a country. Fed being the custodian of the largest economy of the world, it seemed only appropriate that we start off by looking at arguably the most important central bank of the world. (Sullivan 2003, 254)

The United States was the first nation to formalize separation of powers among the three branches in a written constitution, in order to prevent political interference or influence. The Federal Reserve Bank (the Fed) might as well be the fourth branch. It was created by the Congress in 1913 to prevent financial panics. Although its members are nominated by the President and confirmed by the Senate, and it is subject to congressional oversight, its decisions do not have to be ratified by either of the above. Its independence, however, is an issue which is still debatable.

The current financial turmoil in the country has evolved into a global financial crisis, raising concerns regarding the role and accountability of the Fed. In this day of globalization, decisions made by the Fed impact not only the United States, but have consequences worldwide. While it is important for the Fed to remain an independent body for various reasons discussed below; recent events have proven the need for further regulation. (Quinn 2006)

The Federal Reserve Act of 1977 requires the Fed to conduct monetary policy to achieve the basic goals of 'promoting maximum sustainable output, employment stable prices.' The Fed uses various tools to fulfill these which include controlling the reserve requirements, discount rates and conducting open market operations. Open Market Operations are conducted by the Federal Open Markets Committee, which ...