A debate over Fed independence

US Congressman Ron Paul has for long advocated that there is no need of Fed. As he does not make any progress here, he has advocated another idea- complete audit of Fed operations by Government Audit Office.  He has introduced a Bill called Federal Reserve Transparency Act of 2009 which is currently being debated bigtime.

Bernanke has clearly expressed his dislike for the bill. In his presentation of Semiannual Monetary Policy Report to the Congress, he said:

The Congress has recently discussed proposals to expand the audit authority of the Government Accountability Office (GAO) over the Federal Reserve. As you know, the Federal Reserve is already subject to frequent reviews by the GAO. The GAO has broad authority to audit our operations and functions. The Congress recently granted the GAO new authority to conduct audits of the credit facilities extended by the Federal Reserve to “single and specific” companies under the authority provided by section 13(3) of the Federal Reserve Act, including the loan facilities provided to, or created for, American International Group and Bear Stearns. The GAO and the Special Inspector General have the right to audit our TALF program, which uses funds from the Troubled Assets Relief Program.

The Congress, however, purposefully–and for good reason–excluded from the scope of potential GAO reviews some highly sensitive areas, notably monetary policy deliberations and operations, including open market and discount window operations. In doing so, the Congress carefully balanced the need for public accountability with the strong public policy benefits that flow from maintaining an appropriate degree of independence for the central bank in the making and execution of monetary policy. Financial markets, in particular, likely would see a grant of review authority in these areas to the GAO as a serious weakening of monetary policy independence. Because GAO reviews may be initiated at the request of members of Congress, reviews or the threat of reviews in these areas could be seen as efforts to try to influence monetary policy decisions. A perceived loss of monetary policy independence could raise fears about future inflation, leading to higher long-term interest rates and reduced economic and financial stability. We will continue to work with the Congress to provide the information it needs to oversee our activities effectively, yet in a way that does not compromise monetary policy independence.

I came across this hearing at House Committee on Financial Services. It is actually a debate between Scott Alvarez of Fed and Thomas Woods of Ludwig von Mises Institute. Needless to say, Alvarez says no to the Act. Much like Bernanke, he also raises the same issues.

However, Woods has some interesting points as well. He says:

The bill is not designed to empower politicians to increase the money supply, choose interest-rate targets, or adopt any of the rest of the Fed’s central planning apparatus, all of which is better left to the free market than to the Fed or Congress. It seeks nothing more than to open the Fed’s books to public scrutiny. Congress has a moral and legal obligation to oversee institutions it brings into existence. The convoluted scenarios by which merely opening the books will lead to an inflationary catastrophe at the hands of Congress are difficult to take seriously.

At the same time, as we hear this objection repeated time and again, we might wonder just how independent the Fed really is, what with its chairman up for reappointment by the president every four years. Have these critics never heard of the political business cycle? Fed chairmen have been known to ingratiate themselves into the president’s favor close to election time by means of loose monetary policy and the false (and temporary) prosperity it brings about. Let us not insult Americans’ intelligence by pretending this phenomenon does not exist.

I don’t think Fed Chairmen post Volcker have done any favors to President/elections. Anyways, he has a valid point. Actually Fed has got itself into a big hole by massive interventions and bailouts in financial markets post Lehman. And it was all very non-transparent and one was clueless (see my posts on this here and here). All the transparency and disclosures about Fed operations came much later. True there was no time to disclose and the premium was on quick action, but then such actions open up wounds. These actions also serve as the main points of Woods.

Interesting stuff. But let us hope Congress does not get better of Fed here. Yes, there should be some accountability of Fed actions in crisis. But it should not go too far. Central Bank independence is very important and will set a very bad precendent for the rest of the world.