Central Bank Independence at Low Interest Rates
What this paper finds — and why it matters
This paper constructs a new measure of political pressure on the Federal Reserve from textual analysis of Fed Chairs’ testimonies at Humphrey-Hawkins congressional hearings, and documents that the use of non-traditional monetary policy instruments at the effective lower bound (ELB) led to increased political criticism that predicts legislative actions threatening central bank independence. A model is developed in which the probability of the monetary authority’s future loss of independence is increasing in the use of non-traditional instruments, leading to attenuated monetary responses and higher inflation volatility. The attenuation can be mitigated under an institutional framework with clearly defined targets where the central bank is evaluated by how efficiently it achieves its goals.
Summary based on a working paper version, AI-assisted and human-reviewed. See the linked published article for the authoritative version.
Q1. What is the new measure of political pressure and what does it capture?
The paper constructs a measure of political pressure on the Federal Reserve by analyzing the evolution of critical questions and statements directed at Fed Chairs during semi-annual Humphrey-Hawkins Act testimonies to Congress, and finds that the number of critical statements specifically referencing non-traditional instruments increased significantly following the 2008 financial crisis. The measure tracks not only the volume of criticism but also its content—distinguishing criticism that specifically references the ELB tools from general discontent associated with low interest rate environments—allowing the paper to isolate the effect of unconventional policy use from other factors associated with the ELB subsample.
Q2. What is the empirical link between political criticism and legislative threats?
Following Hess and Shelton (2016), the paper analyzes bills introduced to Congress that threaten the powers of the Federal Reserve, and finds that the new measure of congressional criticism correlates highly with the introduction of such threatening legislation; moreover, the number of threatening bills specifically mentioning unconventional monetary policy is predicted by the amount of criticism referencing new policy tools. This provides an empirical chain from the use of non-traditional tools to political blowback to concrete legislative risk to Fed independence, motivating the theoretical model.
Q3. How does the threat to independence affect monetary policy in the model?
In the model, when the probability of future loss of independence is increasing in the use of non-traditional instruments, the optimal monetary authority chooses attenuated responses—using non-traditional tools less aggressively than the unconstrained inflation-minimizing policy would prescribe—thereby generating higher inflation volatility as a consequence of the political risk. The model captures the democratic reality that a central bank’s independence is inherently revocable by the legislature; a central bank that interprets congressional criticism as a credible signal of independence risk will internalize this constraint in its policy decisions.
Q4. How can institutional design mitigate the attenuation?
An institutional framework with clearly defined targets where the central bank is evaluated by how efficiently it achieves its goals—rather than by discretionary judgments about the appropriateness of its tools—mitigates the attenuation of monetary responses by narrowing the scope for politically motivated criticism of non-traditional instruments. If critics must evaluate the central bank against transparent targets, they face a higher evidentiary bar for threatening its independence when non-traditional tools are being used to meet those targets; this reduces the political risk of using such tools and restores the unconstrained optimal policy.
Key concepts
Humphrey-Hawkins testimony measure : the paper’s text-based measure of political pressure on the Fed, constructed from the volume and content of critical questions and statements directed at Fed Chairs during semi-annual congressional testimonies; found to predict threatening legislative actions. attenuation of monetary responses : the reduction in the aggressiveness of non-traditional monetary policy use relative to the unconstrained optimal policy, arising from the central bank’s internalization of the political risk of independence loss associated with using non-traditional instruments. clearly defined institutional targets : an institutional framework in which the central bank’s mandate is operationalized as specific measurable targets and the bank is evaluated by its efficiency in achieving them; shown here to mitigate the political risk of non-traditional instruments and restore optimal monetary responses.