Safeguarding Our Economic Stability

March 21, 2024

Q: With political rhetoric heating up, I’m not sure what to think about the Federal Reserve. Pundits of all stripes are bashing the Fed. If it has so many critics, why do we need it? Is it really all that important?

A: Everyone loves to bash central banks. But in the intricate web of modern governance, few institutions are as crucial to safeguarding our economic stability as the Federal Reserve. The Fed holds immense power over interest rates, inflation, and employment levels, and exerts that power by using various tools to set and adjust monetary policy. However, the Fed’s real power lies in its independence.

The Federal Reserve was formed in 1913 in response to our nation's recurring financial panics. Its founders envisioned an entity insulated from the whims of politics, fully capable of making decisions based solely on economic data and expert analysis. Its separation from political influence was deliberate to prevent short-term political interests from undermining the long-term health of the economy.

At the heart of the debate over the Fed’s independence lies the question of accountability. Critics argue that an independent Fed lacks democratic oversight, potentially leading to decisions which favor the elite over the broader populace. But the Federal Reserve is not unaccountable. Few institutions are subject to as much scrutiny as the Fed—whether by Congress, or the public at large. The Fed’s leadership regularly testifies before lawmakers, and its every move is analyzed extensively by economists, investors, and the general press. Moreover, the Fed's dual mandate—to promote maximum employment and maintain stable prices—aligns with broader societal goals, ensuring that its decisions serve the collective welfare.

Political interference in monetary policy has dire consequences. History is full of examples of governments using central banks to pursue political gains, often at the expense of economic stability. Hyperinflation in Zimbabwe, American stagflation in the 1970s, and the economic turmoil in Venezuela are stark reminders of the perils of politicizing monetary policy. When a nation’s central bank becomes the tool of its political leaders, confidence in the currency erodes, inflation explodes, and economic chaos ensues.

In contrast, the Federal Reserve’s independence bolsters investor confidence, maintaining the integrity of our financial markets. Investors can count on the Fed to make sound decisions based on economic fundamentals, rather than political expediency. Interfering with the Fed’s independence would only undermine investor confidence, leading to market volatility and capital flight. In our globalized economy, where capital flows freely across borders, maintaining the credibility of the Fed is vital for attracting investment and fostering economic growth.

Besides economic stability, the independence of the Federal Reserve also safeguards the principle of the rule of law. In democracies, rule of law dictates that decisions should be based on established norms, procedures, and legal frameworks, rather than arbitrary whims. By insulating the Fed from political pressure, the United States upholds this fundamental principle, ensuring that economic policy is guided by expertise instead of political favoritism.

Critics often point to the European Central Bank (ECB) as an example of a politically independent central bank without adequate political oversight or control. However, the ECB's challenges stem from its institutional design and the complexities of managing a monetary union, not its independence. The Eurozone's diverse economies and fiscal fragmentation present unique challenges which require coordinated action beyond monetary policy alone. Blaming the ECB's independence for Europe's economic woes oversimplifies a very complicated issue.

Of course, the Federal Reserve is not infallible. It has made mistakes—some quite serious—and it cannot prevent all economic turmoil. After the Fed was established, the United States suffered through the Great Depression (1929 – 1939), the Great Recession (2007 – 2009), and several other significant but lessor recessions. But Fed action helped moderate the severity of these economic reversals and helped us avoid many others. If we want to improve the Fed, we should focus on efforts to enhance its transparency and accountability, rather than undermine its independence. A robust and independent Fed, guided by good information and insulated from political pressures, is key to our economic resilience.

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Steven C. Merrell  MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey. He welcomes questions that you may have concerning investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA  93940 or email them to