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Fighting the Fed

The US Federal Reserve fears that a proposed law requiring it to use a formal rule to guide monetary policy would limit its independence, while the bill’s proponents argue that it would produce more predictable growth with low inflation. Who is right?

CAMBRIDGE – The US Federal Reserve is battling with members of Congress over a proposed law, the Federal Reserve Accountability and Transparency Act, that would require the Fed to use a formal rule to guide monetary policy. The Fed fears that the law would limit its independence, while the bill’s proponents argue that it would produce more predictable growth with low inflation. Who is right?

In order to understand the conflict, it is useful to compare the Fed’s independence with that of the Bank of England and the European Central Bank.

In Britain, the BoE has “instrument independence” but not “target independence.” The head of the Treasury sets a goal for the inflation rate and leaves it to the BoE to decide which policies will achieve that goal. If the target is missed by more than one percentage point on either side, the BoE’s governor must send an open letter to the head of the Treasury explaining why (and what the Bank proposes to do about it).

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