[W]hile one can argue that by agreeing to purchase up to $300 billion in long-term U.S. Treasuries, the FOMC provided a needed short-term tonic to private credit markets, we dare not come to be viewed as a handmaiden to the Treasury. By loosening the anchor we have established for long-term inflation expectations, we could create the perception that monetary policy is subject to political imperatives, doing lasting damage to our ability to maintain price stability and restore full employment. I believe we have come as close as we dare to the line between acceptable and unacceptable risk in this regard, and do not personally wish for us to expand or extend our purchases of Treasuries beyond the cumulative $300 billion planned by this fall.

 Any substantial erosion of the Federal Reserve’s monetary independence likely would lead to higher long-term interest rates as investors begin to fear future inflation. Moreover, the bond rating agencies view operational independence of a country’s central bank as an important factor in determining sovereign credit ratings, suggesting that a threat to the Federal Reserve’s independence could lower the Treasury’s debt rating and thus raise its cost of borrowing.¹ Higher long-term interest rates would further increase the burden of the national debt on current and future generations.²

Is monetary policy independence threatened by giving a central bank other responsibilities, such as supervisory and regulatory authority for some parts of the financial system? Are there potential conflicts between a high degree of independence for monetary policy and accountability in supervisory and regulatory policy? I believe that U.S. and foreign experience shows that monetary policy independence and supervisory and regulatory authority are mutually compatible and even have beneficial synergies.

The latitude for the Federal Reserve to pursue its statutory objectives is expressed in several important ways. For example, the Congress determined that Federal Reserve policymakers cannot be removed from their positions merely because others in the government disagree with their views on policy issues. In addition, to guard against indirect pressures, the Federal Reserve determines its budget and staff, subject to congressional oversight. Thus, the system has three essential components: broad objectives set by the Congress, independence to pursue those legislated objectives as efficiently and effectively as possible, and accountability to the Congress through a range of vehicles.

...

The Congress, however, has purposefully--and for good reason--excluded from the scope of potential GAO audits monetary policy deliberations and operations, including open market and discount window operations, and transactions with or for foreign central banks, foreign governments, and public international financing organizations. By excluding these areas, the Congress has carefully balanced the need for public accountability with the strong public policy benefits that flow from maintaining the independence of the central bank’s monetary policy functions and avoiding disruption to the nation’s foreign and international relationships.

When it’s necessary to withdraw the extraordinary stimulus we have put in place, we won’t hesitate. The Fed was created as a politically independent central bank, and that tradition is deeply embedded in our culture and practice.

We've got very large fiscal deficits. We've got the appearance...that the Fed is monetizing the deficit, pushing up yields. Anything that is going to erode the independence of the Fed is going to feed that expectation and drive yields higher.

...

So I think we are really in a delicate situation here as regards the independence of the Fed, and that is an important consideration going forward.

...

The Congress has thought over the last 100 years about how much independence to give the central bank. And when they really think about it, at the end of the day, they want the level of independence that we have. And so I think that will be the end outcome of this.  I don't think anyone involved intends to monetize the debt, but that is what it looks like to outsiders.

As reported by Reuters.

[T]he independence of the European Central Bank must be preserved and the things that other central banks are now doing must be retracted. I view with great skepticism the powers of the Fed, for example, and also how, within Europe, the Bank of England has carved out its own small line. The European Central Bank has also bowed somewhat to international pressure with the purchase of covered bonds. We must return together to an independent central-bank policy and to a policy of reason, otherwise we will be in exactly the same situation in 10 years’ time.

As reported (and translated) by Wall Street Journal.

Congress created the Federal Reserve System with independent regional Reserve Banks and a Board of Governors in Washington that provided checks and balances — checks and balances between centralization and decentralization, checks and balances between the public and private sectors, and check and balances between Wall Street and Main Street — all to ensure that policy decisions were balanced and independent.

Congress also wanted a central bank accountable to Congress, yet not subject to undue political influences. That is why Congress chose to make the Fed independent from the Treasury Department and the administration; why Fed Governors have 14-year terms; why the 12 Reserve Banks are structured more like banks than like government agencies; and why Reserve Bank employees, officers, and directors are generally restricted from engaging in political activities.

We need to draw a bright line once again between monetary policy and fiscal policy. The recent crisis has muddied that separation considerably and we must restore it. The Fed must not be seen by the public or the Congress as a piggy bank that can substitute for difficult fiscal policy decisions.

When a nation's treasury or finance ministry and its central bank work too closely together, there is a clear risk that the government's spending will end up being financed by the central bank's power to create money and that the public will become confused as to their respective roles...Independence is essential to central bank success and the Federal Reserve's current governance and decentralized structure has been an important contributor to ensuring that independence.

The Federal Reserve's response to this crisis in providing liquidity and support to institutions and markets outside of its traditional purview has been significant, creative and timely.
However, in stepping outside its normal sphere of operations and making decisions about which markets and institutions to support, the Federal Reserve has also moved into credit-allocation decisions which are more properly performed by the marketplace itself and by fiscal authorities when necessary.  These decisions have also caused the Federal Reserve to greatly expand its balance sheet and have almost certainly set expectation for similar responses in any future crises.  All of this will make it more difficult for the Federal Reserve to quickly remove its policy accommodation in the future and, thereby, will subject it to new tests of its independence as a monetary authority.

Central bank independence is now widely recognized as an important mechanism for insulating monetary policymaking from inflationary political pressures, and allowing it to respond quickly to short-run macroeconomic developments.

This observation led my former colleague, Marvin Goodfriend, to argue 15 years ago for transferring much of the Fed’s lending activities to the Treasury. He wrote:

“Congress bestows such independence only because it is necessary for the central bank to do its job effectively. Hence, the presumption ought to be that the Fed should perform only those functions that must be carried out by an independent central bank.”¹⁰

While both the Fed and the Treasury can extend credit, only the Fed issues money. Thus, the Fed’s primary focus should be the management of its monetary liabilities.

Goodfriend advocated an understanding or agreement between Fed and Treasury on credit policy, analogous to the 1951 Accord.¹¹ A new “credit accord” that assigns to the Treasury the responsibility for all but very short-term lending to solvent institutions would have a number of advantages, I believe.

One suggestion that would promote a clearer distinction between monetary policy and fiscal policy and help to safeguard the Fed's independence would be for the Fed and Treasury to reach an agreement whereby the Treasury takes the non-Treasury assets and non-discount window loans from the Fed's balance sheet in exchange for Treasury securities. Such an accord would offer a number of benefits.⁴ First, it would transfer funding for the credit programs to the Treasury — which would issue Treasury securities to fund the programs — thus ensuring that credit policies that place taxpayer funds at risk are under the oversight of the fiscal authority. Second, it would return control of the Fed's balance sheet to the Fed, so that we can continue to conduct independent monetary policy. Going forward, an agreement with Treasury would also state that if the fiscal authority at some point wanted the central bank to engage in lending outside its normal operations and, importantly, should the Fed determine "unusual and exigent circumstances" warranted such action, then any accumulation of nontraditional assets by the Fed would be exchanged for government securities.

The Department of the Treasury, the Federal Reserve, the FDIC, and all the financial agencies in our country will bring the full force of the United States Government to bear to strengthen our financial system so that we get the economy back on track.  We have different authorities, instruments and responsibilities, but we are one government serving the American people, and I will do everything in my power to ensure that we act as one.

“I know that, in some ways, my question should be addressed to Secretary Geithner but, as I read it today, you have chosen to now get married, and once you’re married you do have to answer for your spouse — as I do, as my wife does when I write a bad check she has to explain it,” he {Rep. Michael Capuano} told Bernanke.

To which Bernanke replied: “We’re not married, we’re just good friends.

As reported by The Wall Street Journal Real Time Economics Blog.

Mixing monetary and fiscal policy is fraught with risks. Many historical instances of monetary instability have been the result of central banks being prevailed upon to use their balance sheets for fiscal ends in ways that impeded their ability to keep inflation under control. That is why in recent decades, countries around the world have provided a measure of independence to their central banks, within frameworks that ensure accountability, in order to explicitly insulate them from short-run political exigencies that might diminish the credibility of their commitment to control inflation. The cornerstone of that framework in the United States dates back to 1951, when the Treasury-Fed Accord formally gave the Federal Reserve independent control of its balance sheet.⁸

...While at the present time, credit programs do not conflict with our monetary policy strategy, there could well come a time at which monetary stimulus needs to be withdrawn to prevent a resurgence of inflation, even though credit markets are not deemed fully healed. At that time, containing inflation may require closing down credit programs, or finding an alternative, non-monetary financing arrangement for them. Price stability, after all, is the vital first ingredient in financial market stability.