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During hearings on the nomination of Janet Yellen as Chair of the Federal Reserve, Senator David Vitter asked her position on Senator Rand Paul’s bill to audit the Fed. She replied that while she supports “transparency,” she also guards “independence,” and so opposes the bill. The two things – transparency and independence – are not the same.
The argument for independence is strong. There is a negative correlation between central bank independence and the rate of inflation. In countries with more independent central banks, the decision of the political branches to deficit spend is made separately from the decision of the central bank to finance the deficit with newly-created money. The political branches are therefore subject to the discipline of the bond market. Thus, central bank independence both directly (by immunizing the money supply from deficits) and indirectly (by subjecting the budget to the discipline of the bond market) supports sound money.
The gold standard could be viewed as the ultimate form of independence. Indeed, with a gold standard, you wouldn’t even need a central bank. Or, if you have a central bank along with a gold standard, the central bank’s power over the money supply would be limited. Hopefully, it would be able to, and would actually intervene during times of financial crisis so as to prevent deflation from breaking out (something the Fed failed to do during the Great Depression).
With fiat money, because there is no natural check on the money supply, central bank independence becomes very important. Furthermore, the goals of monetary policy also become important. Is the goal exclusively to maintain the purchasing power of the monetary unit, to include preventing both inflation and deflation? Or, are there multiple (and even conflicting) goals, such as fighting both inflation and unemployment, and possibly also keeping the interest rates on government debt low?
The more expansive are the goals for monetary policy, the more difficult it is to discern what the central bank is trying to do. Is the central bank, for example, compromising on inflation to fight unemployment? Do huge deficits put pressure on the central bank to expand the money supply? Because of these uncertainties, it is argued, the financial markets need to “listen in” to the deliberations of central bankers so as to maintain confidence in their fidelity to the goal of maintaining th purchasing power of the monetary unit. Transparency, therefore, has little to do with being accountable to the political branches of government. It’s about allaying the concerns of the financial market in the face of accommodative monetary policy.