Institutional independence is crucial, but its scope is limited given the complexity and fluidity of markets.
The Federal Reserve’s (Fed) Financial Stability Report, released on November 7, highlights political uncertainty and geopolitical risks as the top threats to the United States and the global economy.
In this scenario, the independence of the monetary authority is currently being questioned by the intentions of Donald Trump– and the possibility of changes in interest rate policy, particularly following the firing of Governor Lisa Cook, increase volatility and uncertainty in the immediate future.
The President of the Federal Reserve Bank of New York, John Williamsstressed these days that the independence of the Fed is “incredibly important” since it allows the central bank to control inflation without interference from political power, recalling that the countries that have lost this independence have suffered “terrible consequences” for price stability and therefore for the entire economy.
Fed independence is “incredibly important” because it allows the central bank to control inflation without interference from political power (Williams)
At the same time, Williams warned against large-scale investments in artificial intelligence (AI), noting that they would transform global demand for capital, describing it as “the next level of productivity improvement.”
Although he acknowledged possible problems in labor markets, he considered that technological progress in the past had ultimately facilitated the creation of new jobs by increasing the productivity and effectiveness of investments. Suffice it to remember that a hundred years ago there were neither automobile factories nor many other industries that now employ the majority of workers.
Williams also reiterated that the Fed’s commitment to the 2% annual inflation target is a “very good commitment” – in his words – confirmed by the neutral rate estimates (rThis point becomes clearer when analyzing the famous r (R-star or neutral interest rate), cornerstone of contemporary monetary policy.
The r is postulated as the theoretical level of the equilibrium real interest rate: the economy would reach its full potential, with stable inflation and optimal employment, and monetary policy would be neither expansionary nor contractionary. Some cite three key implications:
- would like to work long-term equilibrium point;
- would guide monetary policy (at a real interest rate above r the position would be contractionary, at a lower interest rate it would be expansionary); And
- would depend on it structural factors such as potential growth, demographic changes, productivity or the relationship between savings and investments.
But the crucial difficulty lies in this r is never observable in the real world.
In short, Fed independence may be viewed as a desirable mechanism to buffer the urgencies and constraints of the political cycle, but it is not all-powerful.
Its operation remains artificial, dependent on estimates and decisions outside of the real market, and its mathematical instruments – including the revered r – remain imperfect approximations of inevitable, complex and ever-changing phenomena.
The challenge for the monetary authority is to embrace the modesty of its instruments, accept the limitations of quantitative forecasts and adapt its strategy to actual economic life.
The challenge of the monetary authority – in the United States or in any other economy – is to embrace the modesty of its instruments, to accept the limitations of quantitative forecasts and to adapt its strategy to real economic life, always in motion, always in real time.
The author is a member of the advisory board of the Center on Global Prosperity, Oakland, California