Monday, May 04, 2009

Fed Independence and Ben Bernanke's Incentives: How to be Re-Appointed?

Allan Meltzer has a thought provoking editorial in today's New York Times. He accuses Ben Bernanke of being "too close" to the Treasury Department and not "independent" enough. A microeconomist might ask; "what are Ben's incentives here?" If his sole goal is to be re-appointed as Fed Chair in 2010 then of course he will follow his Boss's orders. If he has more long run social preferences; equally weighting long term growth and inflation, then perhaps he would act more "independently". Now, a dumb question. What do the words "Independent Fed Chair" actually mean? Is this a subjective expectation or a realization of past actions? So if for every 10 times the Treasury asks Ben to do something , if only follows 5 of those orders; he looks "more independent" than if he followed all 10 orders.

A good macro historian would ask the following question; how many times have Fed Chairs come up for reappointment in the middle of a recession where people are pointing fingers. I would bet that Fed Chairs in this vulnerable position are less independent than a "Greenspan at the peak of a boom".

If we anticipate that our Fed Chairs will be vulnerable to capture by the White House and Treasury in the midst of a recession when they hope to be re-appointed, does this mean that our system of "checks and balances" doesn't really work at such times?

How can we protect Fed Independence at such vulnerable stages? (i.e when we are in recession and the White House is hinting that it will replace the Fed Chair in the following year unless ...)