Free exchange highlights the growing tension between Congress and the Fed, and throws in some implications for inflation:
Political control of monetary policy must inevitably lead to accelerating inflation and long-run economic instability. But at the moment, the American economy could use an increase in expected inflation. And a real threat to Fed independence would almost certainly deliver it, either because markets would anticipate increased political influence on monetary policy ever after, or because the Fed would seek to fend off pressure from Congress by easing further, which amounts to the same thing. But we don’t actually want there to be a real threat to Fed independence, because that way uncontrolled inflation lies.
How does one try to influence the Fed while simultaneously keeping it independent? It’s a tricky question. It is perhaps best to keep Congress out of things entirely, even if current Fed policy is both foolish and harmful.
This suggests the Fed is facing a bit of a paradox now. The more pressure Congress piles on the Fed to “DO SOMETHING!” the more likely it is that anything the Fed does will be interpreted as a response to political pressure, which makes it harder for the Fed to do anything.
Then again, any inflationary action the Fed takes may decrease the political pressure on Congress to challenge the Fed’s independence.
So a more inflationary policy on the part of the Fed may either signal that independence is either weakening or that it is strengthening, depending on the political feedback loop. One thing is clear though, the more Congress breathes down the Fed’s neck, the harder it is to figure out how to manage expectations and thus determine what the right policy is.