Congress Owes Us a More Accountable Fed

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The Federal Reserve is an institution which represents tremendous systemic risk, more systemic financial and economic risk than anyone else. Actions of the Fed, based on the debatable theories and guesses of a committee of economists, can create runaway consumer price inflation, runaway asset price inflation, force negative real returns on the savings of the people, reduce real wages, stoke disastrous financial bubbles which lead to financial collapses, distort markets, and in general, create financial instability-all, of course, in the name of pursuing stability. The Fed has done or is doing all of these.

It is high time to make the Fed more accountable. Senator Richard Shelby's Financial Regulatory Improvement bill, passed by the Senate Banking Committee last May, sets a promising direction for this essential reform.

The first three words of the bill are "To improve accountability." Among its most important provisions is improving the accountability of the Federal Reserve to Congress, especially through its Section 501, "Reports to Congress." This would require the Fed's Open Market Committee to make substantive quarterly reports to the two Congressional banking committees on its policy decisions, reasoning, monetary rules if any, strategy, economic analysis and forecasts, and, as appropriate, dissenting opinions.

Greater accountability for the unelected Fed to the elected legislature would certainly be good. Whenever this is discussed, two objections inevitably arise: "The Fed must be Independent!" (this one loudly from the Fed itself) and "You can't have mere politicians dealing with monetary policy!" (this one especially from professional economists). These objections are misplaced.

The Fed is a continuing effort at central planning and price fixing by committee. Like all such efforts, it has the inescapable problem of insufficient knowledge demonstrated by F. A. Hayek. It is faced with virtually infinite complexity and massive uncertainty. So the Fed is equally as bad at foreseeing the economic and financial future, including what the results of its own actions will be, as everybody else is. Small wonder that, while employing hundreds of economists and running complicated models, it regularly confirms the saying that "economic forecasting was invented to make astrology look good."

In spite of the risk it creates for everyone else, in spite of its unavoidable lack of the requisite knowledge, Federal Reserve officials and supporters endlessly prate that it has to be "Independent." They seldom or never consider how it should be accountable.

Should any part of a democratic government, let alone one with such immense power and riskiness, be free of any serious accountability to the legislature, free of checks and balances? It should not-no matter how much it longs to be fully independent of them, no matter how much it thinks that mere elected representatives of the people can never understand the mysteries of its high calling. Naturally, every bureaucrat's dream is to be free to exercise power without having to bother with legislatures. This dream should never be granted to any part of the government, including the committee of economists known as the Fed. The necessity of democratic accountability must qualify in whatever sense the Fed is independent.

At various times throughout its history, especially during wars, the Fed has been entirely subservient to the Treasury Department and devoted itself to loyally financing the government deficit. At all times, it is ultimately the creature of the Congress, which can, if political stars are aligned, rewrite the Federal Reserve's legal basis. Congress has sometimes chosen to do this, notably when it took the Fed's gold in 1933, centralized Federal Reserve power in Washington in 1935, and revised the Fed's mandates in 1977. But how the Fed should be accountable to Congress in its ongoing actions and policy from year to year is not at all clear. Senator Shelby's bill would substantially clarify it.

In a recent speech, Jean-Pierre Danthine, the Vice Chairman of the Governing Board of the Swiss National Bank (Switzerland's central bank), instructively considers the relationship of independence and accountability. While saying that the bank should be and is independent, he adds that "the SNB's independence is far from unlimited." For: "Independence goes hand in hand with accountability," and "the SNB is accountable to the Federal Council, the Federal Assembly, and the public for the decisions it takes, the means it chooses and the results it achieves" (or, we should add, fails to achieve).

Mr. Danthine specifies in this context, "the annual accountability report submitted to parliament" and "regular meetings with the Federal Council and representatives of the relevant committees of the Federal Assembly." This increases transparency, but "transparency is not a goal in itself, but rather a means to achieve accountability." "It is a fact," he concludes, "that Switzerland has a well-developed system of checks and balances obliging the SNB to transparently account for its decisions."

This articulates a rational and desirable goal, one fully consistent with what is required of the Fed in Senator Shelby's bill. The bill requires the Fed's Open Market Committee, rather than the Federal Reserve Board, to make the required reports. This makes sense because the Open Market Committee has the statutory assignment for making the interest rate and credit interventions which are called "monetary policy." Moreover, using the Open Market Committee is true to the "Federal" in Federal Reserve, because in addition to the Washington board, it includes the presidents of the Federal Reserve Banks spread throughout the country. That makes it a broader group with greater intellectual diversification.

As Congress returns to business, let's hope it can achieve a more accountable Federal Reserve.

 

Alex J. Pollock is a distinguished senior fellow at the R Street Institute in Washington, D.C. He was President and CEO of the Federal Home Loan Bank of Chicago from 1991-2004.  

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