The Federal Reserve: A Study in Soft Constraints

Abstract

This article argues that “soft constraints” are a critical and overlooked complement to formal limitations on an agency's independence. Two types of soft constraints that have been influential checks throughout the history of the Federal Reserve illustrate their power. The first, principled norms, are broadly agreed upon standards as to how the Fed ought to act in a given set of circumstances. As reflected in frequent invocations of the real bills doctrine, Bagehot’s dictum, and the Taylor rule, principled norms both shape Fed action and provide a frame for assessing those actions, A second important soft constraint is the reputation of the Fed Chair. Fed Chairs often serve for exceptionally long periods, exercise significant influence while in office, and are held accountable, by politicians, the press and academics, for actions the Fed takes while they are in office. Although neither of these constraints is perfect or perfectly binding, they are critical complements to the more commonly recognized mechanisms for constraining agency discretion. The article further suggests that soft constraints may be particularly important in settings, like central banking, where there are drawbacks to relying too heavily on formal tools to enhance accountability.

Keywords: Federal Reserve, administrative law, independent agencies, central bank independence

JEL Classification: E58, H10, K00, N10