This was a relatively busy week for monetary policy in Washington. On Wednesday, the Federal Reserve published the minutes of its June Federal Open Market Committee (FOMC) meeting, and on Thursday the House Financial Services Committee held a hearing on H.R. 5018, the Federal Reserve Accountability and Transparency Act.
The biggest news from the FOMC minutes release was that the Fed could finish up its program of bond purchases as early as October. Markets were somewhat rattled by this, as stock market growth in recent years has largely tracked monetary base growth. Despite the possible wind-down, however, the Fed still maintains that it will keep the federal funds rate at or near zero well after quantitative easing has ended. And most FOMC participants supported a continued reinvestment of earnings from the Fed’s securities portfolio into new securities. So just because quantitative easing (QE) may be coming to an end does not mean that accommodative monetary policy will be ending. It will be interesting to see how markets react once QE3 comes to an end. If markets are unsettled, and if economic performance remains weak, it may put pressure on the Fed to restart bond purchases.
The Federal Reserve Accountability and Transparency Act was introduced on July 7th by Congressman Bill Huizenga (R-MI). On Thursday, the House Financial Services Committee held a hearing on the bill. While the Washington Post described the legislation as “Audit the Fed on steroids,” that is a gross mischaracterization.
First, the bill’s good points. It would require the Federal Reserve Chairman to testify in front of Congress quarterly rather than semiannually. In practice, the Fed Chairman normally testifies four times a year already (the semiannual Humphrey-Hawkins hearings in front of the House and Senate banking committees and twice in front of the Joint Economic Committee), so this bill would mandate two extra appearances. As some Members pointed out during the hearing, the Chairman meets with Treasury every week, but with Congress only twice a year. And those appearances are generally limited to about three hours, of which only about two hours are question and answer sessions. Four hours of interrogation per year isn’t really a lot of time for Members of Congress to exercise any effective oversight of the Fed.
The bill also mandates that the Fed notify Congress 90 days before entering into negotiations with foreign or multinational institutions. While Fed defenders quibble about the 90-day notice requirement, there are ways to rewrite the mandate that should be able to appease both sides. In any case, that’s a very good step towards Congress being kept informed about the Fed’s negotiations with foreign central banks. There were a number of instances during my time on the Hill when the Fed Chairman or some other Fed official would postpone a previously scheduled appearance at the last minute because he was flying off to Switzerland or London. The appropriate Congressional committees of oversight should be kept apprised of those international engagements and what is discussed at them.
Now for the bill’s defects, and they are severe. The bill requires the FOMC to adopt a monetary policy rule. While not explicitly requiring the well-known “Taylor Rule,” the bill requires that the FOMC must adopt a monetary policy rule, requires that the Fed include numerous mathematical functions and coefficients and, in the event that the monetary policy rule adopted deviates from the Taylor Rule, must explain in detail and justify why that monetary policy rule deviates from the Taylor Rule.
The problem with the Fed’s monetary policy is not that it engages in discretionary monetary policy vs. rules-based monetary policy, but the fact that it engages in monetary policy at all. Interest rates are prices, and the Fed by setting or targeting various interest rates is engaging in price-fixing. Price-fixing of any sort is economically destructive, particularly when the price of credit is being fixed. Drive the price too low and you artificially stimulate demand for credit; drive it too high and you artificially reduce demand for credit. That wreaks havoc in the economy. But whether that price-fixing comes about through a discretionary process or through a rules-based method based on some sort of mathematical formula is irrelevant – both processes will result in economic dislocation. That is what the authors of H.R. 5018, and indeed many conservatives in Washington, fail to realize.
The emphasis on mathematical precision also assumes that the economy is some sort of machine that responds to certain inputs in a precise manner that can be calculated or predicted. This is an error that has been critiqued and corrected over decades by many Austrian School economists. The fact that such ideas maintain any currency in policy circles is largely due to the influence of Milton Friedman and monetarism within conservative policy circles. Until policymakers realize that the economy is made up of millions of people who purposefully act to better their lives and achieve their hopes and dreams, and who cannot be reduced to a mere mathematical model, such misguided thinking will continue to permeate policy discussions.
Finally and most importantly, the audit provisions of H.R. 5018 are only triggered in certain circumstances, are not necessarily as far-ranging as Audit the Fed legislation, and do not provide for thorough, ongoing future audits. Furthermore, by tying a Federal Reserve audit to changes in monetary policy and using those audits as a punitive measure, H.R. 5018 gives ammunition to those critics of Audit the Fed who assert that proponents of Federal Reserve audits support Congress setting monetary policy rather than the Fed.
Audit the Fed permanently removes the exclusions on auditing open market operations, discussions with foreign central banks, etc., that have hamstrung previous attempts to audit the Fed, and it is intended to shed light on what the Federal Reserve is doing and who on Wall Street has been benefiting from Fed action. Regardless of the type of monetary policy being undertaken and whether or not Congress agrees with it, the Fed should be audited. Proponents of Audit the Fed do not want Congress setting monetary policy any more than they want the Fed setting monetary policy, but if someone is setting monetary policy then their actions should be audited.
H.R. 5018, by dictating that the Fed adopt a monetary policy rule and by tying Fed audits to changes in that rule, is essentially saying to the Fed: “If you engage in monetary policy in a way that we don’t like, we’ll audit you.” That attitude towards audits will only make it easier for opponents of Federal Reserve transparency to spread misinformation about Audit the Fed, and make it more difficult for proponents of Audit the Fed to pass much-needed legislation to shed light on the Federal Reserve’s actions.
Image: Wikimedia/Martin Falbisoner