Members of Congress have done such a great job lately on fiscal policy. Why not put them in charge of monetary policy, too?
Maintaining the independence of the Federal Reserve is crucial to keeping inflation low and ensuring economic stability. Congressional interference with the independent decisions of our central bank on interest rates and on other aspects of our money supply would surely spell economic disaster.
But such disaster could lurk at the bottom of the slippery slope of a current proposal for more Congressional "oversight" of the Fed. This proposal has largely been overlooked during all the talk about derivatives and other divisive matters in the complicated political end game over "Wall Street reform." Overlooking it could have dire consequences for our economic future.
This potentially disastrous "oversight" proposal would subject the interest rate policy of the Federal Reserve, along with other Fed actions, to audits by an arm of the Congress, the General Accountability Office. It is buried amid much that is good in the comprehensive bill on financial reform that was passed by the House of Representatives last December.
Proposed by Ron Paul of Texas and Alan Grayson of Florida, the GAO audit proposal has more than three hundred co-sponsors in the House. Sponsors Bernie Sanders of Vermont and Jim DeMint of South Carolina have enlisted more than 30 co-sponsors for such broad audits in the Senate, which is moving toward a vote on financial reform.
Senate Banking Committee Chairman Chris Dodd of Connecticut does not support the House audit measure, but his energies have mostly been focused elsewhere in trying to cobble together the bipartisan compromises needed to pass a Senate bill.
The Obama Administration likewise opposes the House audit proposal. The President's chief economic adviser, Larry Summers, has denounced it. So have numerous economists.
Why the concern? After all, under current law, the GAO already audits the Fed's stewardship of most of its responsibilities -- everything from bank supervision to consumer regulation to payment systems. Why not change the longstanding practice of excluding monetary policy from Congressional audits, and have the GAO audit the Fed's decisions on interest rates, too? Why should the Fed's making of monetary policy be done independently of scrutiny and second-guessing by the duly designated agents of our elected representatives?
The question of the need for an independent central bank free from the sway of political influence in determining our money supply is not new to me. Nor is it new to our country.
Soon after I was appointed to the financial services committee during my first weeks in the Congress, in 1991, I was invited to a lavish breakfast at the Fed. I still remember the elegant dining room, the linen table cloth, the shining silver, and, especially, the ornate chandelier. And I remember asking myself: how much did that chandelier cost, and who paid for it?
I remember wondering: Why did these lordly central bankers deign to court me, a lowly freshman? The answer soon became clear. They wanted to make certain I would not be seduced into supporting proposals pending even then that would have submitted the independent decision-making of the Fed on monetary policy to the passing political whims of the Congress.
Yes, I did want to know all about that chandelier, and I thought the taxpayers should know about it, too. But I had read entirely too much American history ever to support any legislation that would limit the necessary independence of the Fed. I knew that our recurring national reservations about the need for an independent central bank had long hindered the progressive economic growth of our republic.
During the 1790's, Alexander Hamilton wanted to establish the credit of the new nation and create a climate conducive to investment by creating a national bank. He saw such a bank as the best way to consolidate and finance the national debt, ensure a stable money supply, and spur national growth. Thomas Jefferson and James Madison feared the centralizing tendencies of such an innovation, and doubted its constitutionality.
President George Washington sided with Hamilton. The first bank of the United States was established. But our ambivalence about the need for a national bank remained, and the first bank was abolished in 1811 when the Congress narrowly refused to extend its charter.
The financial necessities of an emerging commercial economy soon inspired the establishment of a second bank of the United States in 1816, and Chief Justice John Marshall blessed it as "necessary and proper" constitutionally in 1819 in McCulloch v. Maryland.
However, Andrew Jackson disagreed, and the second bank became the vilified target of the wrath of Old Hickory in the "bank wars" of the 1830's. No fan of banks of any kind, Jackson denounced it as a "monster" and a "hydra of corruption." In his famous veto of an extension of the bank's charter in 1832, he warned of the dangers of "such a concentration of power in the hands of a few men irresponsible to the people."
Jackson's victory in the "bank wars" was a triumph for Jacksonian Democracy. It was also a hindrance to the continued growth of a commercial economy. The loss of a national bank fed a round of reckless speculation, fueled inflation, and worsened the economic "panic" of 1837 by leaving the rapidly growing country without a national banking system.
It took the pressing need for financing a civil war (and the absence of opposing votes from seceded Southerners) for the Congress to find the resolve to create one, in 1863. It took a half century more to create a true central bank.
By "the progressive era," the need for a strong central bank to facilitate credit and to ensure stability for a complex industrial society was compelling. The Federal Reserve Act of 1913 was the signal accomplishment of Woodrow Wilson's "New Freedom" -- and a delicate political compromise between Wall Street and Main Street.
The debate then foreshadowed much of the debate now. Wall Street wanted a central bank controlled by Wall Street. Main Street wanted a decentralized bank independent of Wall Street. The "progressives" in both parties sought a national banking system under government management that would be independent of both bankers and politicians alike.
The resulting compromise established a Federal Reserve System that was both independent and largely decentralized. Later, during the New Deal, the Congress consolidated the regulatory powers of the Fed in a centralized board of governors, but the essence of the original compromise in 1913 continues to this day.
All along, from the Jeffersonians to the Jacksonians, from the agrarian populists to the Southern New Dealers, and from the Wright Patmans of the 1950's and 1960's to the Sanders and DeMints and Pauls and Graysons of today, generations of Members of Congress have railed against the very notion of an independent central bank in a representative democracy. There is little in Paul's recent tome End the Fed that was not foreshadowed in Andrew Jackson's stump speeches in the 1830's.
The raillery of these Congressional critics has rarely been without cause. Certainly it is not without cause today. As Senator Evan Bayh of Indiana has said of the decision-makers at the Fed, "They have not been perfect."
This is a decided understatement. Former Fed Chairman Alan Greenspan has acknowledged his overreliance on an unregulated market. Fed leaders have admitted that their failure to tighten underwriting standards could have helped prevent the subprime lending crisis in the housing industry that had so much to do with causing our "Great Recession." The handling of the bailout by the New York Fed has, understandably, inspired trenchant Congressional criticism of the lack of "transparency" in the decision-making of the central bank.
These are only a few of the examples that might be cited of how the imperfections of the Fed -- in not fulfilling its regulatory responsibilities, in not protecting consumers from predatory practices, in pursuing bailouts, and in spending seemingly endless taxpayer dollars -- have rightly angered the voters and their elected representatives in the Congress. If I were still in the Congress, I would be joining wholeheartedly with my former colleagues in denouncing many of the recent actions and inactions of the Fed.
But are the undeniable personal mistakes of some of the recent and current stewards of the Fed -- however costly and blameworthy they may be -- cause for us to risk the continuing independence of the Fed as an institution? Are they cause enough to give Congress the legal right to second-guess the Fed on interest rates and other decisions about monetary policy?
Members of Congress can't even figure out a way to work together across party lines to stop printing and spending money we don't have. Whatever our justifiable frustrations with the Fed, do we really want Congress to have a say in setting the price of money, too?
Unlike the Fed, Congress is not independent. Congress answers to the voters. The voters want credit. They want ready money on generous terms. This was true in the early days of our republic. It is true today. It will always be true.
If given a say in determining interest rates, Members of Congress would be unable to resist the inevitable political pressures to loosen the supply of money to their constituents by keeping rates as low as possible. This would certainly be true now, when so much of what Members of Congress are hearing back home is that banks, despite all the bailouts, and despite all the stimulus, are simply not lending money. Last year, US banks posted their sharpest declines in lending since 1942.
Yet, as much as we desire, and desperately need, an increasing flow of credit to hasten our economic recovery, we need a credible currency even more. We continue to need a central bank with the independence to resist political pressures of all kinds, and with the freedom to raise interest rates, when the time is right, to protect the integrity of our money supply by curbing the ever-looming threat of inflation.
Moreover, as Summers has said on behalf of the President, "We support what's necessary for the Fed to be transparent," but "a great deal of research demonstrates that an independent Federal Reserve is really crucial, not just if we're to avoid inflation but also to keep interest rates down over time and to maximize growth in employment."
At the end of the slippery slope of too much Congressional "oversight" of the monetary policymaking of the Fed lies a fate for us akin to that of Argentina, whose president recently forced the resignation of the head of that country's central bank, and raided the bank's foreign reserves to help pay for a level of public spending far beyond what Argentina can afford. Is that what we want for the United States? More deficit spending?
To be sure, the House bill professes neither to hinder nor to interfere with the Fed's making of monetary policy. The fine print in the House provision would require a 180-day lag before the release of Fed actions on interest rates, and it would exclude unreleased transcripts and minutes from Fed decision-making.
But simply saying that these broadened audits would not intrude on monetary policy -- as the sponsors do -- does not make it so. If we widen GAO audits too broadly, if we open up the details of interest-rate setting too much, Congressional and other political second-guessing will intensify, a chilling effect within the Fed will ensue, and cumulative outside pressures will be imposed on the Fed over time that will politicize the setting of interest rates. And, as all too many other countries have done before us, we will slide slowly down the slippery slope toward financial instability.
Fed Chairman Ben Bernanke's initial reaction to the audit proposal in the House bill was to warn, correctly, that a "takeover" of monetary policy by the Congress could destabilize the market. Chastened by the rocky run-up to his recent reappointment, and eager to retain the Fed's authority to supervise banks, he now seems willing to compromise on the audit issue.
While insisting that "the conduct of monetary policy continue to be insulated from short-term political pressures," he has endorsed expanding the current scope of Congressional oversight to permit the GAO to review much of the Fed's day-to-day operations, including accounting, contracting, and financial reporting, as well as the Fed's management of all facilities created under emergency authorities.
Evidently, Bernanke is willing to let the Congress know the cost of the chandelier in the Fed's dining room. But he is rightly determined to preserve the independence of the Fed in the making of monetary policy.
This leaves room for a reasonable compromise, and Chairman Dodd seems to be seeking one. He has reportedly included in the Senate bill a narrower audit proposal by Senator Jeff Merkley, an Oregon Democrat, that would permit GAO audits of the Fed's extraordinary emergency lending powers and its purchases of toxic assets -- but not of its deliberations on interest rates.
This strikes the right balance. It would make the Fed more "transparent" and thus more accountable. But it would not send us sliding down the slippery slope toward economic ruin. Financial reform is urgently needed. But not at the price of the essential independence of the Federal Reserve in controlling our money supply.
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James Bacchus served on the financial services committee while a Member of Congress, from Florida. Later, he was Chairman of the Appellate Body of the World Trade Organization. He chairs the global practice group of the Greenberg Traurig law firm.
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