Spring 2021
G. Epstein, Democratic Money: Central Bank Independence vs. Contested Control (Part 1)


August 10, 2021

Gerald Epstein, Professor of Economics and Co-Director, Political Economy Research Institute (PER) University of Massachusetts Amherst

Part One: The Problem – The Illusory Nature of Central Bank Independence

The US Constitution calls for three branches of government that are independent from one another and that can act as “checks and balances” on each other: The Executive, Congress and the Judiciary. [1] No one seriously suggests that the Pentagon should be politically independent from the Federal Government, nor the State Department, nor the Treasury Department. Yet, it is commonly believed that the Federal Reserve should be “independent”. If the President tries to tell the Fed what to do, critics and pundits cry out: “But that is a violation of Federal Reserve Independence!” This is not necessarily a matter of left or right. Jared Bernstein (Chief Economic Advisor to Joe Biden when he was Vice President and now a member of President Biden’s Council of Economic Advisors) provided Testimony the House Committee on Financial Services entitled “The Critical Importance of an Independent Central Bank”.[2] Progressive legal scholar and activist Robert Hockett, a contributor to this round table, supports having the technicians at the Federal Reserve adjust monetary policy to achieve full employment without inflation, rather than more Congressional or Executive Control over the Federal Reserve which, in his view, would likely mess things up.[3]

When legendary anti-inflation fighting chair of the Federal Reserve, Paul Volcker, died in late 2018, the press lauded his defense of Federal Reserve “independence”.[4] And, of course, there is the inside view: Janet Yellen, as Chair of the Fed, staunchly defended the Fed’s independence. For example, in a 2015 letter to Nany Pelosi and Paul Ryan opposing a congressional bill designed to have the Federal Reserve to a formula in its monetary policy, Yellen wrote:

These provisions are significantly flawed… Most importantly, the provisions effectively cast aside the bipartisan approach toward monetary policy oversight developed by the Congress in the late 1970s. Under that approach, the Congress establishes the long-run objectives for monetary policy but affords the Federal Reserve a considerable degree of independence in how it goes about achieving those statutory goals, thus ensuring that the conduct of monetary policy is insulated from political influence. This framework is now recognized as a fundamental principle of central banking around the world.[5]

Alan Greenspan captured well the inside view:

It is generally recognized and appreciated that if the Federal Reserve’s monetary policy decisions were subject to Congressional or Presidential override, short-term political forces would soon dominate. The clear political preference for lower interest rates would unleash inflationary forces, inflicting severe damage on our economy.[6]

Apart from the philosophical and legal issues that surround this claim for Federal Reserve “independence”, there are quite important issues of political economy at stake.[7]

The main problems with these defenses of “central bank independence” are: first, they assume that the central bank can be “independent”; and, second, they assume that if they were independent, central banks would try to operate in the best interests of society as a whole. Both of these assumptions are simply wrong.

First, there is no such thing as central bank independence per se. This is not because, as some argue, the Federal Reserve, for example, is actually controlled by Congress or by the President. It is because there are underlying political-economic forces that make complete “independence” impossible in a capitalist (quasi?) democracy like the United States. As Bob Dylan put it, “you gotta serve somebody.” In the US, the Federal Reserve won its relative independence from politicians by soliciting a new master: Wall Street.

Finance is a natural ally of the Fed for both structural and political reasons. As Christine Desan and others have argued, legally and structurally the Federal Reserve shares with the commercial banks the role of creating the economy’s money supply. With open market operations in Treasuries and REPO management as dominant tools, the Fed has, for years, been highly dependent on Wall Street for carrying out its monetary operations.[8] This creates a structural imperative to protect these firms and markets, but also means that Federal Reserve officials interact intensely with these institutions and inevitably come to share their culture and perspectives, at least to some extent. There is an implicit regulatory component to this design –for example, the designation and regulation of broker/dealers who handle the Fed’s open market purchases and sales.[9] And, of course, there is an explicit set of regulatory mandates with respect to the Fed’s regulatory functions. All of this means that the Fed has many carrots and sticks to offer banks and Wall Street to induce their loyalty and political support, and that the banks have a huge incentive to play along. It also means that, as a regulatory agency, the Fed’s relationship with finance provides plenty of opportunities for standard “capture” style dynamics of, for example, the “revolving door” variety.

To be sure, the Fed is and remains a creature of Congress and ultimately subject to its authority. But, for over half a century, as made clear by the quote above from former Chairs Greenspan and Yellen, Fed officials have argued that Congress should leave its creature alone. On their view, the Fed must be highly autonomous from Congress and, in fact, it would be dangerous if it were otherwise. When the Federal Reserve and other central banks were closely under the control of the government, they chafed at the control and actively fought to free themselves. For example, during the Second World War, when the Federal Reserve and the Bank of England were dominated by their country’s Treasury Departments and forced to finance the war at relatively low, fixed interest rates, top central-bank leaders commiserated with each other. In a letter from Alan Sproul, New York Federal Reserve President to Montagu Norman, legendary governor of the Bank of England, Sproul asked if the Bank of England would be interested in buying some US War Bonds. Sproul complained: “I am faced with the necessity of becoming a salesman…”. In his reply, Norman bemoaned, “I am with longing for the old days!”[10]  For both Sproul and Norman, the “old days” meant a substantial amount of discretion and authority to establish interest rates and monetary conditions, subject only to the constraints of the Gold Standard. These old days would not return for Norman, but after protracted and intense political battles, they did eventually return for both the Federal Reserve and the Bank of England, along with the other leading western central banks. The ways in which these central banks achieved their “freedom” from the dominant control of their governments is that they cultivated and organized their natural, powerful constituency: finance. Alan Sproul and the New York Fed actively engaged commercial bankers and insurance companies to support more Fed autonomy from the U.S. Treasury.[11] Garnering this support, of course, had its price. In the World War II original agreement to peg interest rates, Sproul fought for a higher long-term interest rate peg. Sproul wrote: “The rate should be fair to the market in that, while we might have the power to finance the war at whatever rate we dictate, it seemed desirable to help preserve our banking system and our institutional investors.”[12] Towards the end of the War, Paul Samuelson complained that the Fed and Treasury had paid investors too much for war funding, remarking in the premier economics journal: “This war is a 2% war. It should have been a 1% war.[13]

Eventually, the Federal Reserve was able to mobilize enough finance and other business support to break loose from government control. In 1951, Fed officials reached what is now known as the Treasury-Fed Accord. After the Accord, the Federal Reserve fought for more and more autonomy by cultivating its banker and finance constituency. That is to say: the Federal Reserve became more “independent” of the government, but only at the expense of becoming more “dependent” on the banks and the financial industry more broadly.[14]

Similar fights by central banks and their business allies occurred after the Second World War in European Social Democracies as well. As Avner Offer and Gabriel Soderberg show in their fascinating book, The Nobel Factor, the Swedish Central Bank even went so far as to use its share of the seigniorage from Swedish money creation to fund a pseudo Nobel Prize in Economics, partly in order to enhance the prestige of free-market economists such as Hayek and Milton Friedman in its fight against social democratic control of the Swedish Central Bank.[15] The title tells that tale: The “Nobel Prize in Economics” is officially called “ the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel.”

Ironically, Milton Friedman, recognized this flaw in the idea of central bank “independence.” In 1962, Friedman wrote in an essay entitled “Should There Be an Independent Monetary Authority?” that: “An independent central bank will almost inevitably give undue emphasis to the point of view of bankers…In the United States, for example, the Reserve Banks are technically owned by their member banks. One result is that the general views of the banking community exercises a strong influence on the central bank…”[16]

In short, in democratic societies, central bank “independence” is politically contingent: it can be taken away or greatly curtailed by politicians. As a result, central banks cultivate and rely on political allies to augment and preserve their political independence from governments. And their most natural allies are the bankers: they regulate them, they interact with them on a daily basis, they can trade favors with them, and they often share the same outlook. In addition, more perfidious relationships also operate, as with all regulatory agencies, most notably, the revolving door.

So, there is no such thing in our social and economic system as “central bank independence.” Maintaining central bank independence from elected officials requires the central bank to become dependent on political allies, which are often financial institutions.

The second basic flaw in the standard arguments for “central bank independence” is that advocates assume that if central banks were politically independent, they would try to operate in the public interest. If they failed, it was because of technical mistakes, rather than deliberate policy choices. This appears to be the implicit assumption, for example, in Robert Hockett’s intervention in this round table. But, as I have already suggested, central bankers tend to see the world through “finance-colored glasses” and this strongly impacts their policies. There are, of course, two broad sets of policies under the authority of the Federal Reserve: monetary policy and financial regulatory policy. Historically, both of these have often been conducted with a firm eye to their impact on bank and finance profits. My colleague Tom Ferguson and I showed that the Fed failed to sufficiently expand open market operations in 1932, because the Regional Federal Reserve Banks were worried about the negative impact of lower interest rates on their member banks’ profits.[17] Despite the Federal Reserve’s dual mandate of high employment and stable prices, until the 2000s, and especially after Paul Volcker’s chairmanship, the Fed has continued Alan Sproul’s policy of high real interest rates. Arjun Jayadev and I have shown that, holding other factors constant, higher real interest rates are associated with increases in financial wealth holders’ shares of income.[18] Olivier Coibion and co-authors at the IMF have shown that, from Paul Volcker’s rein in the 1980s until the early 2000s, the Federal Reserve has persistently reduced its inflation target. This led to contractionary monetary policy and increased interest rates, contributing to significantly to higher unemployment, slower economic growth and increases in inequality.

Starting in the 2000s, the economic situation changed, leading to different monetary policy by the Fed. Under the direction of Alan Greenspan, with inflation firmly in check, the Fed pursued a different monetary policy, the so-called “Greenspan Put,” leading to LOWER interest rates, designed to support increases in asset prices.[19] With changed circumstances (controlled inflation, partly because of the neoliberal assault on labor organizing, and partly because of competition from China), the Fed engineered a different policy: low interest rates, but for largely the same reasons: –to increase the wealth of finance and other wealthy groups.[20]

The policies the Federal Reserve pursued in the 2008 financial crisis and then again, in response to the Covid Panic starting in March 2020, of buying trillions of dollars in financial market assets and taking extraordinary measures to underwrite the global financial markets, further expanded the wealth disparities between finance, capital owners, and everyone else.[21]

On the regulatory front, the story is even clearer. As Arthur Wilmarth Jr., among many others, has shown, in the post-War period, and especially under the chairmanship of Alan Greenspan, the Federal Reserve has aligned itself with large Wall Street banks to erode and dismantle New Deal regulatory rules, including the Glass-Steagall Act’s restrictions on affiliations between commercial banks and other types of financial firms such as broker dealers and insurance companies.[22] By helping to bring about the emergence of megabanks, the Federal Reserve forced the hand of Congress to adopt further statutory changes and set up the dynamics that, along with other factors, would precipitate the 2008 collapse. According to the Federal Reserve, that crisis cost the US economy at least $12 trillion. It would take a massive amount of creative accounting to demonstrate that another two, four, or even six percentage points of annual inflation, the bogeyman that Greenspan was so concerned a democratic Federal Reserve would allow, could possibly have cost our society anywhere near this amount.

In short, when the Fed sees the world through finance-colored glasses and becomes dependent on finance in order to preserve its “political independence” from the public and elected officials, not only does it distort the country’s income and wealth distribution, but it also undermines the basic duties of the central bank to protect the health of the economy.


[1] Many thanks to Dan Rohde, Lev Menand and Chris Desan for their excellent suggestions and encouragement that have greatly improved this intervention. All errors, of course, are mine alone.

[2] Bernstein, July 20 2017.

[3] See, also, Robert Hockett and Aaron James, Money From Nothing; Or Why We Should Stop Worrying about Debt and Learn to Love the Federal Reserve (Brooklyn: Melville House, 2020.)

[4] See for example, Michael Klein, Paul Volcker’s legacy, an independent Federal Reserve, is under threat, PBS, December 12, 2019.

[5] Yellen, November 16, 2015: https://www.federalreserve.gov/foia/files/ryan-pelosi-letter-20151116.pdf.

[6]The Challenge of Central Banking in a Democratic Society”, Remarks by Chairman Alan Greenspan at the Annual Dinner and Francis Boyer Lecture of The American Enterprise Institute for Public Policy Research, Washington, D.C., December 5, 1996.

[7] For some of the more abstract issues, See Paul Tucker, Unelected Power; The Quest for Legitimacy in Central Banking and the Regulatory State (Princeton: Princeton University Press, 2018.)

[8] See Christine Desan’s brilliant “How to Spend a Trillion Dollars: Our Monetary Hardwiring, Why it Matters, and What We Should Do About it” Draft (May, 2021). Robert Hockett in this round table, also discusses some of these issues.

[9] See Robert McCauley, “Nurturing US securities firms: a century of public policy” in Gerald Epstein, et. al., eds, Banking, Monetary Policy and the Political Economy of Financial Regulation. These connections and breadth of transactions widened greatly with the interventions during the Great Financial Crisis and the pandemic rescue operations (see, for example, Desan, ibid.)

[10] Allen Sproul to Montagu Norman, March 3, 1943, Federal Reserve Bank of New York, Bank of England Files. See Gerald Epstein, The Political Economy of Central Banking: Contested Control and the Power of Finance. (Northampton, MA: E. Elgar Press, 2019), Ch. 5.

[11] Ibid.

[12] Ibid.

[13] Paul Samuelson, “The Effect of Interest Rate Increases on the Banking System”, American Economic Review, 35:16-27, p. 26.


[14] Stefan Eich, in his interesting post for this round table, also raises this issue of the Fed’s dependence on finance.

[15] Avner Offer and Gabriel Soderberg, The Nobel Factor; The Prize in Economics, Social Democracy, and the Market Turn. (Princeton: Princeton University Press, 2016.)

[16] Milton Friedman,. “Should There Be an Independent Monetary Authority?“, in Leland B. Yeager ed., In Search of a Monetary Constitution (Harvard University Press: Cambridge, MA and London, England, 1962), pp. 219-243.


[17] Gerald Epstein and Thomas Ferguson, “Monetary Policy, Loan Liquidation and Industrial Conflict: The Federal Reserve and Open Market Operations of 1932”, Journal of Economic History, XLIV (4), December, 1984, 957-83.

[18] “The Rise of the Rentier Incomes in OECD Countries: Financialization, Central Bank Policy and Labor Solidarity”, in Gerald Epstein, ed. Financialization and The World Economy, (Northampton: Edward Elgar Press, 2005).

[19] Generally, there is an inverse relationship between interest rates and asset prices—so a reduction in interest rates, assuming inflation is more or less constant, will lead to an increase in asset prices.

[20] Epstein, 2019, supra, Ch. 14; Christine Desan, “How to Spend a Trillion Dollars”, supra; Peter Dietsch, Francois Clavenau and Clement Fontan, Do Central Banks Serve the People? (London: Polity Press, 2018.) and the references therein.

[21] Epstein, 2019, supra, Ch. 20; Robert Pollin and Gerald Epstein, “Neo-Liberalisms Bail-Out Problem” 2021.

[22] Arthur E. Wilmarth, Jr. Taming the Megabanks; Why We Need a New Glass-Steagall Act. (New York: Oxford University Press, 2021).


Return to Central Bank Independence roundtable prompt.