Ben S Bernanke: Central bank independence, transparency, and
accountability
Speech by Mr Ben S Bernanke, Chairman of the Board of Governors of the Federal Reserve
System, at the Institute for Monetary and Economic Studies International Conference, Bank
of Japan, Tokyo, 25 May 2010.
The original speech, which contains various links to the documents mentioned, can be found on the US Federal
Reserve System's website.
* * *
The financial crisis that began nearly three years ago has caused great hardship for people
in many parts of the world and represented the most profound challenge to central banks
since the Great Depression. Faced with unprecedented financial stresses and sharp
contractions in economic activity, many central banks, including the Federal Reserve,
responded with extraordinary measures. In the United States, we lowered the federal funds
rate target to a range of 0 to 1/4 percent to help mitigate the economic downturn; we
expanded the scale, scope, and maturity of our lending to provide needed liquidity to
financial institutions and to address dislocations in financial markets; we jointly established
currency swap lines with foreign central banks (including the Bank of Japan) to ensure the
global availability of dollar funding; and we purchased a large quantity of longer-term
securities to help improve the functioning of financial markets and support economic
recovery.1 Looking to the future, central banks around the world are working with their
governments to prevent future crises by strengthening frameworks for financial regulation
and supervision.
In undertaking financial reforms, it is important that we maintain and protect the aspects of
central banking that proved to be strengths during the crisis and that will remain essential to
the future stability and prosperity of the global economy. Chief among these aspects has
been the ability of central banks to make monetary policy decisions based on what is good
for the economy in the longer run, independent of short-term political considerations. Central
bankers must be fully accountable to the public for their decisions, but both theory and
experience strongly support the proposition that insulating monetary policy from short-term
political pressures helps foster desirable macroeconomic outcomes and financial stability.
In my remarks today, I will outline the general case for central bank independence and
review the evolution of the independence of the Federal Reserve and other major central
banks. I will also discuss the requirements of transparency and accountability that must
accompany this independence.
The case for central bank independence
A broad consensus has emerged among policymakers, academics, and other informed
observers around the world that the goals of monetary policy should be established by the
political authorities, but that the conduct of monetary policy in pursuit of those goals should
be free from political control.2 This conclusion is a consequence of the time frames over
which monetary policy has its effects. To achieve both price stability and maximum
sustainable employment, monetary policymakers must attempt to guide the economy over
time toward a growth rate consistent with the expansion in its underlying productive capacity.
Because monetary policy works with lags that can be substantial, achieving this objective
requires that monetary policymakers take a longer-term perspective when making their
decisions. Policymakers in an independent central bank, with a mandate to achieve the best
possible economic outcomes in the longer term, are best able to take such a perspective.
In contrast, policymakers in a central bank subject to short-term political influence may face
pressures to overstimulate the economy to achieve short-term output and employment gains
that exceed the economy's underlying potential. Such gains may be popular at first, and thus
helpful in an election campaign, but they are not sustainable and soon evaporate, leaving
behind only inflationary pressures that worsen the economy's longer-term prospects. Thus,
political interference in monetary policy can generate undesirable boom-bust cycles that
ultimately lead to both a less stable economy and higher inflation.
Undue political influence on monetary policy decisions can also impair the inflation-fighting
credibility of the central bank, resulting in higher average inflation and, consequently, a
lessproductive economy. Central banks regularly commit to maintain low inflation in the longer
term; if such a promise is viewed as credible by the public, then it will tend to be self-fulfilling,
as inflation expectations will be low and households and firms will temper their demands for
higher wages and prices. However, a central bank subject to short-term political influences
would likely not be credible when it promised low inflation, as the public would recognize the
risk that monetary policymakers could be pressured to pursue short-run expansionary
policies that would be inconsistent with long-run price stability. When the central bank is not
credible, the public will expect high inflation and, accordingly, demand more-rapid increases
in nominal wages and in prices. Thus, lack of independence of the central bank can lead to
higher inflation and inflation expectations in the longer run, with no offsetting benefits in
terms of greater output or employment.3
Additionally, in some situations, a government that controls the central bank may face a
strong temptation to abuse the central bank's money-printing powers to help finance its
budget deficit. Nearly two centuries ago, the economist David Ricardo argued: "It is said that
Government could not be safely entrusted with the power of issuing paper money; that it
would most certainly abuse it....There would, I confess, be great danger of this, if
Government - that is to say, the ministers - were themselves to be entrusted with the power
of issuing paper money."4 Abuse by the government of the power to issue money as a
means of financing its spending inevitably leads to high inflation and interest rates and a
volatile economy.
These concerns about the effects of political interference on monetary policy are far from
being purely theoretical, having been validated by the experiences of central banks around
the world and throughout history. In particular, careful empirical studies support the view that
more-independent central banks tend to deliver better inflation outcomes than
lessindependent central banks, without compromising economic growth.5 In light of all these
considerations, it is no mystery why so many observers have come to see central bank
independence as a critical component of a sound macroeconomic framework, and
economists have studied a variety of approaches to enhance the independence and
credibility of monetary policymakers.6
To be clear, I am by no means advocating unconditional independence for central banks.
First, for its policy independence to be democratically legitimate, the central bank must be
accountable to the public for its actions. As I have already mentioned, the goals of policy
should be set by the government, not by the central bank itself; and the central bank must
regularly demonstrate that it is appropriately pursuing its mandated goals. Demonstrating its
fidelity to its mandate in turn requires that the central bank be transparent about its economic
outlook and policy strategy, as I will discuss further in a moment. Second, the independence
afforded central banks for the making of monetary policy should not be presumed to extend
without qualification to its nonmonetary functions. For example, many central banks,
including the Federal Reserve, have significant responsibilities for oversight of the banking
system. To be effective, bank regulators and supervisors also require an appropriate degree
of independence; in particular, the public must be confident that regulators' decisions about
the soundness of specific institutions are not unduly influenced by political pressures or
lobbying. But for a number of reasons, the nature and scope of the independence granted
regulatory agencies is likely to be somewhat different than that afforded monetary policy. In
the conduct of its regulatory and supervisory activities, the central bank should enjoy a
degree of independence that is no greater and no less than that of other agencies engaged
in the same activities; there should be no "spillover" from monetary policy independence to
independence in other spheres of activity. In practice, the Federal Reserve engages
cooperatively with other agencies of the U.S. government on a wide range of financial and
supervisory issues without compromising the independence of monetary policy.
The case for independence also requires clarity about the range of central bank activities
deemed to fall under the heading of monetary policy. Conventional monetary policy, which
involves setting targets for short-term interest rates or the growth rates of monetary
aggregates, clearly qualifies. I would also include under the heading of monetary policy the
central bank's discount-window and lender-of-last-resort activities. These activities involve
the provision of short-term, fully collateralized loans to the financial system as a means of
meeting temporary liquidity needs, reducing market dysfunctions, or calming financial panics.
As has been demonstrated during financial panics for literally hundreds of years, the ability of
central banks to independently undertake such lending allows for a more rapid and effective
response in a crisis. On the other hand, as fiscal decisions are the province of the executive
and the legislature, the case for independent lender-of-last-resort authority is strongest when
the associated fiscal risks are minimal. Requiring that central bank lending be fully secured,
as is the case in the United States, helps to limit its fiscal implications. Looking forward, the
Federal Reserve supports measures that help further clarify the dividing line between
monetary and fiscal responsibilities. Notably, the development of a new statutory framework
for the resolution of failing, systemically important firms is not only highly desirable as a
means of reducing systemic risk, but it will also be useful in establishing the appropriate roles
of the Federal Reserve and other agencies in such resolutions.
The issue of the fiscal-monetary distinction may also arise in the case of the nonconventional
policy known as quantitative easing, in which the central bank provides additional support for
the economy and the financial system by expanding the monetary base, for example,
through the purchase of long-term securities. Rarely employed outside of Japan before the
crisis, central banks in a number of advanced economies have undertaken variants of
quantitative easing in recent years as conventional policies have reached their limits. In the
United States, the Federal Reserve has purchased both Treasury securities and securities
guaranteed by government-sponsored enterprises.
Although quantitative easing, like conventional monetary policy, works by affecting broad
financial conditions, it can have fiscal side effects: increased income, or seigniorage, for the
government when longer-term securities are purchased, and possible capital gains or losses
when securities are sold. Nevertheless, I think there is a good case for granting the central
bank independence in making quantitative easing decisions, just as with other monetary
policies. Because the effects of quantitative easing on growth and inflation are qualitatively
similar to those of more conventional monetary policies, the same concerns about the
potentially adverse effects of short-term political influence on these decisions apply. Indeed,
the costs of undue government influence on the central bank's quantitative easing decisions
could be especially large, since such influence might be tantamount to giving the government
the ability to demand the monetization of its debt, an outcome that should be avoided at all
costs.
The historical evolution of central bank independence
Support for the idea of central bank independence has evolved over time. In the United
States and many other countries, the historically high and volatile inflation rates in the 1970s
and early 1980s prompted a reexamination of monetary policies and central bank practices.
Since that time, we have observed the confluence of two global trends: the widespread
adoption of improved monetary policy practices and the virtual elimination of high inflation
rates. The improved policy practices prominently include a broad strengthening of central
bank independence, increased transparency on the part of monetary policy committees, and
the affirmation of price stability as a mandated goal for monetary policy. Inflation targeting, in
which the government sets a numerical target for inflation but assigns responsibility for
achieving that target to the central bank, has become a widely used framework embodying
these principles, but other similar monetary frameworks have also proved effective.
In recent years, the number of central banks with a relatively high degree of independence
has steadily increased, and the experience of some major central banks testifies to the
importance of that independence. The Bank of England, one of the oldest central banks in
the world, was essentially an agent of the British Treasury for a substantial part of the
20th century. When the government announced on May 6, 1997, that the Bank of England
would be reborn as an independent central bank, U.K. Treasury bond yields fell sharply at
longer maturities, likely reflecting a substantial decline in investors' inflation expectations and
their perceptions of inflation risk. Moreover, several studies have shown that U.K. inflation
expectations exhibited significantly greater stability in the years following independence.7
Prior to the creation of the European Central Bank (ECB) in June1998, independence was
seen as such a crucial element that it was enshrined in the Maastricht Treaty, an
international agreement that can only be changed by unanimous consent of its signatories.
The independence of the ECB has helped to keep euro-area inflation expectations firmly
anchored.8
The importance of central bank independence also motivated a 1997 revision to Japanese
law that gave the Bank of Japan operational independence.9 This revision significantly
diminished the scope for the Ministry of Finance to influence central bank decisions, thus
strengthening the Bank of Japan's autonomy in setting monetary policy.
Although the Federal Reserve was established as an independent central bank in 1913, its
effective degree of independence has gradually increased over time. Initially, the Secretary
of the Treasury and the Comptroller of the Currency sat on the Board; they were removed
when the current structure of the Federal Open Market Committee (FOMC) was introduced
with the Banking Act of 1935. The act also extended the terms of Board members from
10 years to 14 years; the long, staggered terms of Board members have also served as a
brake on political influence.
During World War II, the Federal Reserve agreed to peg Treasury yields at low levels to
reduce the cost of financing wartime deficits. After the war, the Fed sought to resume an
independent monetary policy, fearing the inflationary consequences of continued political
control, but the Treasury was still intent on containing the cost of servicing the debt. The
conflict was resolved in 1951 through the negotiation of the Treasury-Federal Reserve
Accord, as it came to be known. The accord reestablished the Federal Reserve's ability to
freely set interest rates, but with active consultation between the Fed and Treasury. It was
only by the amendment of the Federal Reserve Act in 1977 that the Fed's current objectives
of maximum employment and stable prices were specified by the Congress.10 A clear
mandate of this kind is a key pillar of central bank independence.
Over the years, a consensus developed among U.S. political leaders that the Federal
Reserve's independence in making monetary policy is critical to the nation's prosperity and
economic stability. In 1978, the Congress formally recognized this principle by approving a
provision that exempts monetary policy, discount window operations, and the Fed's
interactions with other central banks from Government Accountability Office policy reviews.
In 1979, President Carter appointed Paul Volcker chairman of the Federal Reserve with the
expectation that Volcker would strengthen the central bank's inflation-fighting credibility, even
though those steps would likely involve short-term economic and political costs.
Subsequently, President Reagan's support for Volcker's politically unpopular disinflationary
policies and for the principle of Federal Reserve independence proved crucial to the ultimate
victory over inflation, a victory that set the stage for sustained growth.11 Presidents and other
U.S. political leaders have since then regularly testified to the benefits of an independent
Federal Reserve. For instance, President Clinton said in 2000, "[O]ne of the hallmarks of our
economic strategy has been a respect for the independence and the integrity of the Federal
Reserve."12 President Bush noted in 2005, "It's this independence of the Fed that gives
people not only here in America[,] but the world, confidence."13 And President Obama said in
August 2009, "We will continue to maintain a strong and independent Federal Reserve."14
10
The Employment Act of 1946 established the objectives of "maximum employment, production, and
purchasing power" for all federal agencies, whereas the 1977 amendment to the Federal Reserve Act gave
the Federal Reserve the specific mandate of promoting "maximum employment, stable prices, and moderate
long-term interest rates." Price stability requires that the central bank not attempt to drive employment above
its sustainable level, and so in practice the Federal Reserve has interpreted its mandate to include maximum
sustainable
employment. The goal of moderate long-term interest rates is frequently dropped from statements
of the Federal Reserve's mandate not because the goal is unimportant, but because moderate long-term
interest rates are generally the by-product of price stability.
11
For example, in February 1982, President Reagan stated: "This administration will always support the political
independence of the Federal Reserve Board." See Reagan (1982).
12
See Clinton (2000).
13
See Bush (2005).
14
See Obama (2009).
BIS Review 72/2010
Transparency and accountability
Central bank independence is essential, but, as I have noted, it cannot be unconditional.
Democratic principles demand that, as an agent of the government, a central bank must be
accountable in the pursuit of its mandated goals, responsive to the public and its elected
representatives, and transparent in its policies. Transparency regarding monetary policy in
particular not only helps make central banks more accountable, it also increases the
effectiveness of policy. Clarity about the aims of future policy and about how the central bank
likely would react under various economic circumstances reduces uncertainty and - by
helping households and firms anticipate central bank actions - amplifies the effect of
monetary policy on longer-term interest rates. The greater clarity and reduced uncertainty, in
turn, increase the ability of policymakers to influence economic growth and inflation.15
Over the years, the Federal Reserve - like many central banks around the world - has taken
significant steps to improve its transparency and accountability. Policymakers give frequent
speeches and testimonies before the Congress on the economic situation and on the
prospects for policy, and the Federal Reserve submits an extensive report to the Congress
twice each year on the economy and monetary policy.16 The FOMC, the Fed's monetary
policymaking arm, releases a statement after each of its meetings that explains the
Committee's policy decision and reports the vote on that decision. The FOMC also publishes
the minutes of each meeting just three weeks after the meeting occurs and provides, with a
lag, full meeting transcripts. In addition, the FOMC has begun providing the public a quarterly
summary of Committee participants' forecasts of key economic variables and, more recently,
their assessments of the longer-run values to which these variables would be expected to
converge over time.17 The information released by the FOMC provides substantial grist for
the activities of legions of "Fed watchers" who analyze all aspects of monetary policy in great
detail.
Apart from traditional monetary policy, the Federal Reserve's response to the financial crisis
has involved a range of new policy measures, about which the Fed has provided extensive
information. For example, the Board has regularly published detailed information about the
Federal Reserve's balance sheet and the special liquidity facilities that were introduced. We
created a section on our website devoted to these issues and initiated a regular monthly
report as well.18 And we are committed to exploring new ways to enhance the Federal
Reserve's transparency without compromising our mandated monetary policy and financial
stability objectives.19
Conclusion
As a result of the crisis, countries around the world are implementing significant financial and
regulatory reforms. Such reforms that reduce the chance of a future crisis and that mitigate
the effects of any crisis that does occur are worthy of our full support. As we move along the
path of reform, however, it is crucial that we maintain the ability of central banks to make
monetary policy independently of short-term political influence. In exchange for this
independence, central banks must meet their responsibilities for transparency and
accountability. At the Federal Reserve, we will continue to work to facilitate public
understanding of both our monetary policy decisions and our actions to ensure the
soundness of the financial system.
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