The Political Independence of FED - Essay Example

The financial sector plays a critical role in regulating financial matters in a country, particularly the Central Bank. However, political interference has been blamed for continued interference with how financial regulators operate. This has contributed to the fact that politicians like manipulating and controlling these institutions for their gain.
In his lectures, Bernanke (2012) argued that central banks should be allowed to make independent decisions without political interference to have sound decisions. Studies have documented that political interference in the financial sector not only hinders how these institutions operate but also interferes with how regulators enforce regulations. Financial regulators are, therefore, unable to take action on banks that do not follow the laid down rules and regulations. When political interference is evident in the financial regulatory bodies, recognition of the severity of the crisis is delayed, and the intervention needed is also slowed and consequently raising the cost of the crisis to taxpayers.

Shielding the financial sector from political interference helps to improve the quality of regulation and supervision. This helps in preventing financial crises. Financial regulators have two main purposes. First, they are mandated to protect the consumer. Second, they are also mandated to maintain the financial stability of financial institutions. When political interferences come in, these two roles of the regulator are abandoned. For instance, in 1997, political interference in the regulatory bodies of East Asia led to the postponement of recognition of the severity of the crisis, which led to the increased crisis. In Korea for instance, banks were regulated by the ministry of finance and economy instead of the central bank. Due to the weak regulatory framework of the ministry, the 1997 crisis was realized. In Indonesia, politically connected banks led to poor enforcement of regulations. However, when crisis struck, the central bank overrode procedures of handling the crisis as per the directions directly from the president.
According to Bernanke (2012), individuals in financial regulatory institutions should focus on making long-term decisions rather than just focusing on short-term political interests. In addition, politically appointed individuals to head or manage regulatory bodies would worsen the situation by being motivated by short-run electoral considerations in making decisions, something that would lead to a financial crisis. Studies have documented that in countries where elected officials interfere with monetary policies, the results are excessive inflation. However, in countries with central banks that are independent, average rates of inflation are noted.
Nevertheless, a heated debate has long been on the role of the government in appointing and dismissing individuals to run the central bank. To have such matters cleared, several legal policies have been put in place to allow the central banks to operate independently. For instance, the Federal Reserve’s goals are set in its legal charter, but it has been argued that these goals are described in a vague manner and terms. All in all, since it’s the Fed that sets the goals without any political interference, the level of performance is believed to be better than the goals set by the government for the central bank in some countries.

The level of independence of financial institutions is determined by several factors. First, the chief executive officer of a bank should be appointed by the central bank board instead of the finance minister. Secondly, the central bank is considered to be independent if its charter states that price stability is solely the mandate of the central bank. Lastly, the independence of the central bank is noted higher when a set of limitations are put in place to limit the government's ability to borrow from the central bank.
However, in a country where the rule of law is not strong, the central bank is more highly embedded in the political culture than in the laws governing the institution. In light of this, governments must set up mechanisms of allowing central banks to operate independently. Conversely, the central bank should instill measures that ensure that its objectives take account of the government’s objectives to strike a balance on the best policies to put in place to avoid a crisis. Read More