Federal Reserve Chair Jerome Powell is justifiably proud of the central bank’s independence — and refreshingly candid about its boundaries. The Fed, he said last week, “should ‘stick to our knitting,’ and not wander off to pursue perceived social benefits that are not tightly linked to our statutory goals and authorities. … We are not, and will not be, a climate policymaker.”
Powell’s short remarks, made at a symposium of central bankers in Stockholm, address an argument some of the bank’s critics have been making: The Fed uses its independence to fight inflation, so why can’t it also use it to fight climate change?
Powell’s fear is that if the Fed tries to confront climate change, or strays in other ways from its narrow mandate, it will be drawn into partisan politics. This will make its dual mandate — price stability and maximum employment — harder to achieve.
The Fed shouldn’t make policy on matters that Congress hasn’t told it to. Ensuring that banks properly weigh climate risks does fall within its financial-safety remit, but aiming to steer capital to preferred uses doesn’t. Powell’s also right, as a practical matter, about the need to shield monetary policy from political pressures. The trouble is that the principled case for central-bank independence is increasingly fragile.
As the effects of the pandemic and energy-price shocks fade, inflation is falling from its recent highs in the US and Europe. Unfortunately, it might not drop all the way back to the Fed’s target of 2% without an outright recession. In that case, the Fed will face demands to recast its inflation target and decree that 3% or 4% is good enough for price-stability purposes. If it refuses, it will be asked why throwing people out of work to get from 3% to 2% is not a highly political choice, and what gives the Fed the right to make it.
The traditional answer is less persuasive than it used to be. Economists once believed that any trade-off between jobs and price stability — lower unemployment means higher inflation — is strictly short-term. After a while, unemployment settles at its natural rate regardless, so higher inflation doesn’t help the labor market. And if the central bank insists on keeping unemployment too low, the result isn’t just high inflation but indefinitely rising inflation.
This theory didn’t get politics out of the picture entirely, because there’s still that short-term trade-off. But it made the jobs-and-inflation dilemma less acute. Now, though, this thinking is widely questioned. Maybe very low unemployment doesn’t imply high and rising inflation; maybe, for one reason or another, higher inflation gets you higher output and employment in the medium or longer term. In the second case, the Fed has to judge competing components of the public interest, an inescapably political task.
The pragmatic argument for central-bank independence remains compelling. Changes in interest rates work slowly. They take time to feed through to demand, and then to prices and output. Insulating monetary policy from day-to-day politics allows for a more patient and consistent approach. It also relieves governments of the temptation to use inflation to boost their tax revenues and/or shrink their debt. Because the price-stability mandate is relatively narrow and unambiguous, you can know whether the Fed got things right. In this admittedly limited sense, it’s accountable.
And the results have been excellent. Harvard’s Ken Rogoff, speaking last week on the same panel as Powell, called central-bank independence “the most significant positive development in macroeconomic policy since the Second World War.” For more than 30 years until the pandemic, in the countries where central-bank independence prevailed, inflation wasn’t a problem. Though the Fed and others can be faulted for moving too slowly to curb inflation last year, few would say US and European monetary policy was the decisive factor. Countries without an independent central bank have done worse; often, much worse. Look at Turkey, whose government keeps its central bank on a leash and where inflation is out of control.
So there’s a lot to be said, when it comes to making monetary policy, for keeping politics at a distance. But the question remains: Couldn’t the same be said of climate policy? Perhaps other institutions can be given similar policymaking privileges. Or perhaps central-bank independence can be recruited to serve this purpose.
The Bank of England and European Central Bank have already moved toward climate policy. Both cite vague directives from their respective political superiors to support the transition to net zero. Both have developed plans to, among other things, abandon “market neutrality” in their debt-purchase programs and put a tax of sorts on carbon emissions.
In the UK and the EU, such policies aren’t as controversial as they would be in the US. So they’re less likely to draw fire from critics arguing that the central bank is meddling in areas beyond its primary concern and is making political judgments. For the moment, the US Congress is unlikely to give the Fed any such opening, and the Fed would be unwise to explore the possibilities at its own initiative.
Not, however, because it would be anti-democratic. Central-bank independence is already anti-democratic. It would be wrong because anything that unsettles the current dispensation — the Fed’s freedom to make unavoidably political decisions about monetary policy — would be very expensive. In a democracy, especially one as divided as the US, central-bank independence is a glaring anomaly. Long may it continue.
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