Friday, July 24, 2009
THE FEDERAL Reserve Board's independence is a bit like the judiciary's independence. Absolutely vital for the institution's proper functioning, it nevertheless depends on Congress and the president to respect decisions with which they disagree. In such cases, the best protection for either the Supreme Court or the Fed is to stay strictly within its legally prescribed authority and to act according to principled criteria: legal ones for the justices, technical economic ones for the central bank.
Which brings us to the proposed Federal Reserve Transparency Act, sponsored by anti-Fed crusader Ron Paul (R-Tex.) in the House and socialist Bernard Sanders (I-Vt.) in the Senate. In the name of open government, it would subject the Fed's decisions to a full-blown audit by the Government Accountability Office, the investigative arm of Congress. Though the bill has attracted 276 co-sponsors in the House and 17 in the Senate, it is wrongheaded in the extreme. By opening up the Fed's most sensitive interest rate and credit policies to public second-guessing, the bill would create a risk -- real and perceived -- of monetary policy bent to suit congressional overseers. This would destroy financial markets' faith in the Fed and, by extension, the value of the U.S. dollar, just as surely as a political "audit" of the Supreme Court's deliberations would undercut public faith in the justice system.
However, there is a reason that this bill, unthinkable in normal times, is gaining traction now. Under Chairman Ben S. Bernanke, the Fed has expanded its role in the U.S. economy to an unprecedented extent, making use of its balance sheet to prop up troubled Wall Street firms, the commercial-paper market and much else. Congress, quite understandably, is nervous, with the perhaps inevitable result that Fed-bashing is in vogue on Capitol Hill.
For the most part, Mr. Bernanke's actions have been both necessary and proper, in that federal law authorized him to respond to what have definitely been "unusual and exigent" circumstances. He has tested the limits of his power but not exceeded it. Still, there is no clear mechanism to hold the Fed accountable for any mistakes it might have made that contributed to the crisis in the first place -- or might be making now.
Mindful of that, Mr. Bernanke has done more than any other chairman in recent memory to explain his actions and his institution to Congress and the public. In public hearings this week, he has wisely outlined his plans to unwind the Fed's balance sheet in a non-inflationary way, reassuring the markets that the Fed has no desire for a permanently expanded role in the financial system.
The Federal Reserve Transparency Act is an unserious answer to a serious question. Over the long term, Congress and the president do need to ensure the optimal balance between independence and accountability at the Fed. This is especially true since the Obama administration's proposals for financial regulatory reform would give the Fed even more power, as the arbiter of which firms are "too big to fail." If the Fed is to stay free, it should, to the greatest extent possible, stay focused on its core mission of managing the nation's money supply.