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Working Paper

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This article uses case studies from the history of the Federal Reserve to illustrate the capacity of “soft constraints” to impose meaningful limits on an agency’s effective independence. This analysis suggests that the Federal Reserve is not nearly as unconstrained as it may appear if one looks only at the formal mechanisms limiting its independence. Two types of soft constraints illustrate their power. The first set, principled norms, are principles that are generally accepted by experts and policymakers and that dictate how the Fed ought to act in a given set of circumstances, provide. Using the real bills doctrine, Bagehot’s dictum, and the Taylor rule as examples, the analysis suggests that even when the Fed has no legally enforceable obligation to act in accord with a principled norm, the existence of the norm shapes Fed action and discussions about the same. The Fed Chairperson’s concern with his reputation provides a second and complementary soft constraint on how the Federal Reserve uses its authority. 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 Federal Reserve takes while they are in office. Fed Chairs thus have the incentive and means to influence the Federal Reserve’s actions to enhance their individual reputations. These analyses suggest that soft constraints play a meaningful and underappreciated role shaping Fed action and facilitating transparency and oversight. The article also considers the ramifications of soft constraints for debates about the Fed’s authority and discussions about agency independence more generally. It suggests that soft constraints should reduce the likelihood of arbitrary action, thus serving as a partial substitute for political accountability and enhancing agency legitimacy. Soft constraints also serve as important complements to traditional mechanisms of accountability by increasing transparency and serving as a reference points that facilitates discussion and oversight. The article further suggests that soft constraints may be particularly important in settings where there are significant drawbacks to using formal tools to enhance accountability.