by William C. Dudley, Chair, Bretton Woods Committee; Former President, Federal Reserve Bank of New York

What is central bank independence?

Independence means that the central bank has been given the sole responsibility to conduct monetary policy to achieve the goals established for it by its legislature or parliament. In the United States, this entails Congress establishing the broad objectives of monetary policy with respect to employment and inflation, and the Federal Reserve conducting monetary policy to best achieve those objectives. Congress enumerated the two goals of monetary policy to be price stability and maximum sustainable employment in the Humphrey Hawkins Act (1978).

In other countries, the central banks’ mandates may differ. For example, many central banks have a single mandate that is confined to price stability. And some countries have added an explicit mandate for the central bank to ensure financial stability.

Over the past forty years, there has been significant movement towards greater central bank independence around the world. This trend has been motivated by the observation that independent central banks have been better able to achieve their objectives of low and stable inflation. 

What is the scope of Federal Reserve independence?

The Fed is independent with respect to how it implements monetary policy to achieve the goals established by Congress. In substance, this generally concerns the short-term interest rates that the Fed controls through its monetary policy. But it can also extend to purchases and sales of Treasuries and agency mortgage-backed securities, including its quantitative easing and tightening programs. 

However, the Fed does not decide what these goals are. If Congress were to enact legislation that changed the Fed’s economic objectives, then the Fed would have to adjust monetary policy to best achieve those new objectives. 

The Fed’s independence does not extend to its other responsibilities, such as supervision, regulating US banks, and ensuring the stability of the financial system. In the case of the banking sector, the Fed works with the Office of the Comptroller of the Currency that regulates nationally chartered banks and the Federal Deposit Insurance Corporation to ensure a consistent set of regulations.

With its lender of last resort function, the Fed has independence in terms of the liquidity it provides to banks through the discount window and its conduct of open market operations that influence the supply of bank reserves. In contrast, the Fed’s authority to lend to non-bank entities such as securities firms or to purchase or lend against securities other than Treasuries and agency mortgage-backed securities is sharply limited by law. Although Section 13.3 of the Federal Reserve Act allows the Fed to lend to individuals, partnerships, and corporations in “unusual and exigent” circumstances, such lending requires a super-majority vote by the Board of Governors and approval by the Secretary of the Treasury. Also, there are legal constraints around the scope of these liquidity facilities. For example, they must be broad-based in terms of access and cannot be used to aid a borrower that is insolvent. 

While the Fed has independence with respect to how it conducts monetary policy to achieve its dual mandate objectives, it is subject to Congressional oversight. The Fed has a responsibility to explain and justify its monetary policy decisions. It does this in many ways, including the Chair’s press conference following each FOMC meeting, the minutes to each meeting—which are published three weeks after each regularly scheduled meeting, a semiannual monetary policy report to Congress, testimony by the Chair before the House Financial Services and Senate Banking committees, and speeches by FOMC members. The Fed is subject to reviews by the Government Accountability Office (GAO) and also has an Inspector General to perform oversight on its operations.

Fed independence does not constrain the ability of the President, Congress, and the public to criticize the Fed’s conduct of monetary policy or to advocate for the monetary policy they want the Fed to pursue.

Why is independence important?

It enables a central bank to set monetary policy without consideration to the election cycle. If the Fed were not independent, it might be forced to overstimulate the economy prior to an election. While this might enhance an incumbent party’s election prospects, the potential cost might be higher inflation later. If central bank independence with respect to the conduct of monetary policy were sharply constrained, this could potentially unsettle the bond and equity markets. Investors might demand higher compensation because of the risk of higher and more volatile inflation. 

Does central bank independence foster better economic performance? 

Academic studies¹ have consistently confirmed that independence is consistent with better inflation outcomes and a less cyclical economy. This is one reason why countries around the world have moved to increase central bank independence over the past forty years.

What mechanisms are in place to insulate the Fed from political pressure?

The Fed controls its own budget, and it is not subject to Congressional appropriations. The Fed’s expenses are funded from the Fed’s net interest income, and what remains is turned over to the U.S. Treasury.

While Federal Reserve governors are nominated by the President, they require approval by the Senate. The Federal Reserve governors that hold a majority (7 out of 12) of the voting seats on the Federal Open Market Committee (the Fed’s monetary policy decision-making body) are appointed to 14-year terms, which insulates them from short-term political pressure.  Federal Reserve bank presidents that hold 5 of the 12 voting seats on the FOMC are appointed by the Board of Directors of each Reserve Bank subject to the approval of the Board of Governors. Federal Reserve Presidents can serve for 10 years or until they are 65 years old, whichever is later.

Has the Federal Reserve always had such independence?

No. The Federal Reserve Act (1913) made the Secretary of the Treasury and the Comptroller of the Currency ex officio members of the Board. And, during the Depression and its aftermath, the Fed’s independence was very limited. During World War II, the Fed deliberately kept interest rates low to help finance the war effort. After the War, the Treasury and Federal Reserve agreed in 1951 that the Fed would have an independent authority with respect to its conduct of monetary policy and would not have to conduct monetary policy to cap the Treasury’s borrowing costs. However, even as late as the 1970s, the Fed did not fully exert its independence of monetary policy under then-Chairman Arthur Burns. The high inflation during that period helped facilitate greater support for Fed independence.  

How can the government affect Fed policy?

Congress could enact legislation constraining the Fed’s independence. The President and Congress could attempt to stack the FOMC with appointees who share their economic and political objectives, though this is presently difficult given the long terms of the seven appointed members. If an administration appointed a majority to the FOMC, that FOMC might be more amenable to that administration’s monetary policy wishes. However, even in this case, once appointed the governors and presidents would be able to cast their FOMC votes independent of the wishes of the President and Congress. 

The President does not appear to have the authority to fire existing members of the FOMC in order to simply create open seats on the FOMC. The Supreme Court ruling this spring suggests that a Federal Reserve governor can only be fired “for cause,” which requires proof of “malfeasance, neglect of duty, or inefficiency [i.e., lack of competence and/or poor performance]”. There is less legal clarity about whether this same standard extends to Federal Reserve bank presidents. Also, the Board of Governors may be able to dismiss a Reserve Bank president—even though this has never happened. The Federal Reserve bank presidents have 5-year terms that end on February 28 in years ending with 1 or 6 (thus, next in February 2026).  The Board of Governors has the power to not reappoint a Reserve Bank president, but this is not an authority that the Board has used in the past. The reappointment process has always been routine and uncontroversial.   

Featured Author:

William C. Dudley, Chair, Bretton Woods Committee; Former President, Federal Reserve Bank of New York

1. See, among others, Alesina and Summers (1993); Cukierman, Webb, and Neyapti (1992); Garriga and Rodriguez (2023); and Unsal, Papageorgiou, and Garbers (2022). See Adrian, Khan, and Nemard (2024) for a discussion of CBI measures. ↩︎