The Fed under Attack

What’s at stake: It is becoming increasingly clear that politicians around the world are seeking someone else to blame for the crisis and that, in many countries, that someone is the central bank. In the US, the Federal Reserve is coming under extreme pressure from Congress. On Thursday, Ben Bernanke urged Congress not to take away the Federal Reserve’s bank supervision powers or curtail its independence.

The FT’s Money Supply blog reports that Allan Meltzer – the unofficial historian of the US central bank – thinks that the situation is worse than at any point in the Fed’s history. There is real concern that some of the proposals before Congress to curtail the power of the Fed and its independence will end up becoming law. In another post, the blog reports that these notionally independent organisations are coming under increasing pressure in other countries too. The Bank of Japan has given way to political pressure and introduced new three-month liquidity support operations to banks already flush with liquidity. The ability of the ECB to implement its exit strategy might become more difficult in the following months as governments are siding with the IMF arguing that the ECB should err on the side of caution and not exit too quickly. In the UK, the Conservative leader called for an end to quantitative easing in his party conference speech.

Vincent Reinhart says that the more the Congress expects the Fed to do, the more likely will such doubts blemish its reputation, and hence its independence. If preserving a variety of responsibilities is not only efficient but crucial to protecting the Fed's independence (contrary to the principle of comparative advantage but as argued by Ben Bernanke in an op-ed published by the Washington Post), there should be instances in the FOMC transcripts of informed discussion of the linkages between its supervision role and its monetary policy decisions. Anyone making the case for beneficial spillovers should be asked to produce numerous relevant excerpts that demonstrate these synergies that make expertise in examining banks and writing consumer protection regulations useful in setting monetary policy.

Edwin Truman says that auditing the Federal Reserve is an ill-advised and dangerous step. On November 19, the House Financial Services Committee passed an amendment to its financial reform legislation that would authorize the General Accountability Office (GAO) to audit all aspects of the Federal Reserve’s operations. The amendment would remove previous limitations covering GAO audits of Federal Reserve monetary policy, lending, and certain supervisory activities. If policy actions are to be efficient and effective, accountability cannot always be instantaneous, and transparency cannot always be complete and continuous. The challenge is to strike the right balance. The current proposal would adversely affect the U.S. economy, because the Fed would show greater caution on rate decisions for fear of public retribution from politicians. The danger would lie in the Fed hesitating to act pre-emptively, increasing the risk of costly errors.

Frederic Mishkin and Anil Kashyap write that the Fed is already transparent. It is completely appropriate to hold the Fed accountable for its decisions. But the Paul bill, H.R. 1207, will only produce redundancies: Congress already has multiple ways of finding out what the Fed is doing and why. What's more, it is highly doubtful that the GAO has the technical competence to evaluate monetary policy. If it did try to conduct these audits, at best it would merely rehash known information. At worst, the GAO would generate confusion by offering its own analysis. Alan Blinder makes a similar point.

Cédric Tille says that the current legislative proposals risk weakening the authorities’ capacity to manage future crises. There is little surprise that Congress jibs increasing the supervision role of the Fed and even grumbles on its independence when we look at the Fed performance in terms of regulation ahead of the crisis. But the crisis has demonstrated the need for a regulator that has an overview of all financial markets. Tille, however, argues that the Fed is not necessarily the best placed for such a job, especially if political authorities resists granting the autonomy necessary for the regulator to do its job. In such a scenario, the independence of the central bank could end-up weakened.

Mattew Iglesias says that we shouldn’t be dogmatic about central bank independence as it turns out that an unanticipated negative consequence of central bank independence is systematic deflationary bias in major economies.

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