Congress and the Federal Reserve – A Comment on Their Appropriate Relationship

February 11, 2015

The Federal Reserve System was created by an act of Congress just over a century ago and remains organizationally accountable to that body.  The dual monetary policy mandate to preserve price stability and maximize employment was defined by the Congress and mandated to the central bank.  Federal Reserve officials by law routinely testify before federal lawmakers, publish minutes of FOMC meetings and have initiated numerous modifications in the communication of their policy to increase its transparency.  Comprehensive data pertaining to central bank operations for the Fed’s own account and on behalf of the Treasury and other bodies, as well as figures quantifying the impact of such on the central bank balance sheet are shared with the public and examined by others to verify accuracy.

The supporters of a congressional campaign to “audit the Fed” is really about moving the line that defines the central bank’s authority to act independently along lines that officials believe are in the best interest for meeting its policy mandate, free of interference from elected politicians.  In countries where monetary policymaking has been managed by politicians at times and by appointees credentialed in economics at other times, the latter method has repeatedly been found to be more effective in achieving desired long-term goals.  Because monetary policy changes affect growth and inflation with long and variable lags, decision-making needs to be oriented toward what’s best in the long-term and occasionally by prioritizing that agenda above short-term ramifications, even when those might be negative.  The business of politics way too often emphasizes the short term over the long term.

Fed officials are not infallible.  The 2007 subprime lending crisis, which triggered a series of reactions leading to the Great Recession and from which the European debt crisis was spun off, was identified in advance by too few U.S. monetary officials.  That financial meltdown was potentially much more serious than the initial banking imbalances that brought on the Great Depression, but in the hands of Fed officials trained in knowing the policy mistakes of commission and omission from the 1930s, the U.S. settled for an 18-month recession rather than a multi-year depression.  Incidentally, the Great Depression is so characterized because it was the most severe depression in U.S. history.  It remains the only U.S. depression since the creation of the Federal Reserve, which contrasts with numerous bona fide depressions over the previous 75 years during which the United States had no central monetary institution.

The virtues of central bank independence are especially exemplified in Great Britain, where interest rates were set by elected officials prior to the spring of 1997.  At that time, the newly elected Labour Party government shocked markets by handing responsibility for day-to-day monetary policy exclusively to the Bank of England.  America’s bout with double-digit inflation centered on 1980 spanned slightly less than three years and exceed 13% over just eight successive months.  Britain endured double-digit inflation for four year to end-1977 with a peak of 27% and another 3 years at the time of the U.S. episode with a peak then of 22%.  British CPI inflation averaged about 4% a year over the 9 years prior to the aforementioned handover of monetary policy in 1997.  Over the ensuing 17 years, such averaged 2.1%, very close to the target of 2.0%.  A table documenting almost 70 years of British inflation history can be perused here.

There are some common threads connecting the leadership of the audit-the-Fed movement.  Rand Paul, Ted Cruz, Marco Rubio, Bernie Sanders and Michele Bachmann each has or had presidential aspirations, underscoring the highly political motivation of this call.  For another thing, these are people with limited to no educational background in economics.  In the meritocracy that America aspires to be, credentialing plays a central role in careers that require expertise, whether that involve being an engineer, accountant, plumber, electrician, financial advisor, doctor, or lawyer.  Surprisingly, the standard for political leaders is simply to be convincing, popular, and backed by a support team that knows how to win elections. 

The question should not be whether monetary policy be vested only with properly credentialed people who understand the subject and know how to empirically test whether a sensible-sounding idea actually delivers expected results.  A better matter to question is the sensibility of allowing people to run of Congress or the White House if they lack adequate academic exposure and proven proficiency in general economics, monetary economics, and fiscal policy.  The potential to do economic harm to millions of people is too great a matter to be trusted with people lacking proper know how.

Copyright 2015, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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