Rep. Brady's Fed Reform Creates More Problems Than Solutions

Wednesday's Federal Open Market Committee decision to keep its policy framework unchanged was widely anticipated and yet, still frustrating. The continuation of a zero interest rate policy is the equivalent of offering free money to the banking world. It has had little positive effect on the U.S. economy, and it is only helping the rich get richer.

It is not surprising to hear voices reiterating critiques of the Fed that are almost becoming old hat, but relatively new is the resurrected call for Congress to remove the Fed's dual mandate and, instead, require the Fed to focus on just price stability. There is already a bill in the House that would accomplish just that; the Sound Dollar Act sponsored by Rep. Kevin Brady (R-Texas). But to anyone thinking this bill would put an end to zero percent interest rates and large-scale asset purchases, think again.

Beyond offering solutions, the bill leaves the door open to many more problems than it proposes to solve.

Rather than narrowly focusing the Fed's role, as would be expected in pursuing sound money policy, the Sound Dollar Act actually gives more control and discretion to the Fed governors and presidents as well as explicitly expanding their powers over many more markets than just government securities. Furthermore, the legislative process that will dictate the final language of the bill could potentially result in even further unprecedented responsibilities granted to the Federal Reserve.

In establishing price stability as the single mandate, the Sound Dollar Act requires the Fed to set and evaluate metrics based on the prices and expected returns of residential, commercial and agricultural real estate, all commodities and bonds (municipal, government, and corporate). It also requires the Fed to determine whether the United States dollar is properly priced relative to other currencies as well as to gold. Beyond all this, the Fed must determine "whether any price movements not captured by the price indices of goods and services are causing a significant misallocation of capital in the United States Economy." the bill says.

Judging by the Fed's recent history of expertise on prices and expected returns and the ability to identify a misallocation of capital, why would anyone expect a price stability mandate defined by the above list to succeed? When asked in late 2005 about the possibility of a housing bubble and the potential precipitous decline in home prices across the country, Fed chairman Ben Bernanke replied, "It's a pretty unlikely possibility. We've never had a decline in house prices on a nationwide basis. So what I think is more likely is that house prices will slow, maybe stabilize: might slow consumption spending a bit. I don't think it's going to drive the economy too far from its full employment path, though."

With this historical understanding, it is unlikely that if this legislation had been adopted in 2005 that Fed policy would be much different than it is today.

Perhaps the one exception to this criticism is that that the Sound Dollar Act limits all open market operations to U.S. Government securities and repos. This is a great provision, especially in the shadow of all the Maiden Lanes, equity and junk purchases, and general shenanigans conducted by the Fed throughout the financial crisis. However, the bill allows the Fed to purchase anything it determines necessary to preserve price stability under "unusual and exigent circumstances." Since that clause was the major justification for the unorthodox open market operations of the financial crisis in the first, place, the provision hardly appears to have much in the way of the proverbial bite vs. bark.

The bill is further weakened by a provision that says the Fed, at any time, can change its definition and metrics for price stability if it would help support its desired policies simply by issuing a report to Congress. Consider that the European Central Bank operates under a single mandate and has an even worse track record than the Federal Reserve on accommodative monetary policy, having grown its balance sheet by over $1 trillion since July, 2011 to $3.8 trillion total

Simply limiting the Fed to a single mandate will accomplish nothing in terms of substantive, operational reform.

Even worse, the process of addressing this legislation could itself become an impediment to really achieving sound monetary policy. As usual, the legislative process opens the door to any member to place their own personal stamp on the law should it be passed. Without a strong initial legislative approach and with every responsibility of the Fed on the alteration board, Congressional horse-trading could create no shortage of monetary policy problems for those seeking a less accommodative and influential Fed.

Just consider the history of legislating a mandate for the Federal Reserve.

The Employment Act of 1946, which first required the government to promote policies for maximum employment and which provided a foundation for the Humphrey-Hawkins Act that eventually established the Fed's dual mandate, started out granting the government enormous control over free markets. The Employment Act's supporters believed as then-President Roosevelt did that all have the "right to a useful and remunerative job." They also believed that high levels of unemployment were a natural consequence of free enterprise and claimed in the legislation "private enterprise, left to its own devices, cannot provide full employment and cannot eliminate periodic mass unemployment and economic depressions."

In fact, an early draft of the Employment Act from 1945 went so far as to claim "All Americans ... are entitled to an opportunity for useful, remunerative, regular, and full-time employment. In order to assure the free exercise of the right to an opportunity for employment [...] the Federal Government has the responsibility to assure continuing full employment, that is, the existence at all times of sufficient employment opportunities for all Americans ..."

This language was removed from the final version of the law as critics noted that extending the "right" to employment meant that the federal government would now be responsible for providing jobs to everyone that was willing under the law, despite the bill having no provision on how to enforce the right. Ultimately, it was un-American and alien to the United States' principles. The adopted language states to "promote maximum employment" rather than "assuring continuous full employment" as the bill originally intended.

In the context of 2012's debates on income inequality and continued high rates of unemployment, it is possible that the same cooler heads would not prevail in a debate over the Sound Dollar Act. And since the Act will have no practical operational impact on the Fed given their present statements and views, there is little value to taking the risk on this legislation.

None of this should stand as a defense for the status quo. The Sound Dollar Act is simply not the way to push back on the Fed's continued destructive policies. True reform of the Federal Reserve will involve restricting open market operations and interest rates to pre-defined standards without emergency exceptions. True pursuit of sound money would involve returning to some form of gold standard or legalization of alternative domestic currencies. Anything else is not worth the risk of Congress attempting a solution.