Threatening the Fed's independence
The Federal Reserve's performance in this long-running financial and economic crisis deserves separate grades. For the early crisis period, from the summer of 2007 until a few weeks after the Lehman Brothers failure in mid-September 2008, the Fed's response was uneven. I would question several decisions. But the Fed deserves extremely high marks for its work since then. It has hit the bull's-eye regularly under very trying circumstances.
In academia and in the financial markets, the overwhelming attitude is: Hurrah, and thank goodness, for Ben Bernanke, who gets kudos for his boldness, creativity and smarts.
But not in the political world. The Fed is extremely unpopular in Congress and is facing hostile and potentially detrimental actions from both sides of the aisle. While the reform proposals put forward by the Treasury Department and by House Financial Services Committee Chairman Barney Frank (D-Mass.) would enhance the Fed's regulatory powers, the draft bill by Senate Banking Committee Chairman Christopher Dodd (D-Conn.) would clip the Fed's regulatory wings substantially.
Worse, legislation that just proceeded through the House Financial Services Committee could imperil the Fed's ability to conduct an independent monetary policy. With more than two-thirds of the House co-sponsoring the so-called Paul bill, prospects for floor passage unfortunately look good.
The Federal Reserve Transparency Act sounds like something everyone should support. But the legislation, introduced by Rep. Ron Paul (R-Tex.), is not really about transparency. The implications of H.R. 1207 are suggested more accurately by the title of Paul's best-selling book: "End the Fed." If enacted, this bill would subject the Fed's monetary policy decisions and its dealings with foreign central banks to audit by the Government Accountability Office (GAO) -- which normally acts on requests from Congress. Under current law, these aspects of Fed business have been explicitly ruled off-limits (though the rest is auditable).
Is this extension of the GAO's reach, and hence that of Congress, a good idea? If you believe we'd get better monetary policy with decisions made by Congress in open debate, or heavily influenced by congressional opinion, it certainly is. But how many actually believe that? Very, very few.
H.R. 1207 seems innocuous enough. The overall question it raises sounds fair: After all, why should the Fed be immune from audit? In fact, it is not. The Fed already gets its books examined regularly. Let me assure you, Chairman Bernanke is not flying in private jets or lunching on caviar. Furthermore, the GAO is already authorized to examine most aspects of Fed operations. It can audit the Fed's special financial arrangements for Bear Stearns, AIG, Citigroup and Bank of America -- to name the most prominent examples.
In addition, the chairman and other Fed officials testify frequently before congressional committees, including on monetary policy -- precisely the area in which it is independent of (but accountable to) Congress. And the Fed's monetary policy decisions are dissected and evaluated by markets and the media in excruciating detail on a virtually continuous basis. The Fed gets plenty of scrutiny -- as it should.
But a congressional audit of monetary policy -- remember, the GAO works for Congress -- could easily develop into something quite different. Here is a not-very-hypothetical example:
In all likelihood, the Fed will begin the process of exiting from its current hyper-expansionary monetary policy next year. When it does so, interest rates will start rising even though unemployment is still high. It is entirely predictable that some in Congress will be unhappy with the Fed's decisions, maybe even livid. Would we welcome a critical GAO audit of monetary policy, which members of Congress could use to browbeat, perhaps even to intimidate, members of the Fed's rate-setting body, the Federal Open Market Committee? Would we like to see the FOMC members called on the congressional carpet to explain why they are "killing jobs"? Would we like Congress to override the Fed's decisions and set monetary policy -- which is its constitutional right? I think and hope not.
An independent monetary policy, designed and executed by the Federal Reserve, is one of the great and enduring achievements of the Progressive Era. It has enabled the long time-horizons of technocrats to triumph over the short-term perspectives of politicians, bringing us low inflation over the decades. Because of this, and because technocratic monetary policy seems to be more skillful than political monetary policy, the Fed's independence has been admired and imitated by country after country. Passage of the Paul bill would be a step away from independent monetary policy and a step toward ending the Fed as we know it.
That is a step we should not take.
The writer, a former vice chairman of the Federal Reserve Board, is a professor of economics and public affairs at Princeton University.