Fed’s in­de­pen­dence hangs in the bal­ance

The Washington Times Weekly - - Commentary -

The threat of politi­ciza­tion hangs over the Fed­eral Re­serve Board like the Sword of Damo­cles. It’s Capi­tol Hill’s re­sponse to the Fed’s pro­lif­er­a­tion of new pro­grams to unglue credit mar­kets. The Fed’s in­no­va­tions threaten to cre­ate enough acronyms to tax the lim­its of the al­pha­bet.

Rep. Bar­ney Frank, Mas­sachusetts Demo­crat and chair­man of the House Fi­nan­cial Ser­vices Com­mit­tee, which over­sees the Fed­eral Re­serve, has warned, “There is a prob­lem with too much power go­ing to an en­tity that is not sub­ject to demo­cratic pow­ers.” The Fed should be “ac­count­able to vot­ers.”

Rep. Ron Paul, Texas Repub­li­can, has au­thored a Fed trans­parency bill call­ing for Fed au­dits. The bill has more than 200 co-spon­sors, and the num­ber is ris­ing daily. It’s just a “first step,” Mr. Paul says.

Sen. Christo­pher J. Dodd, Con­necti­cut Demo­crat and chair­man of the Se­nate Bank­ing Com­mit­tee, which shares over­sight re­spon­si­bil­i­ties for the Fed­eral Re­serve Sys­tem, also wants more Fed trans­parency as well as an eval­u­a­tion and closer scru­tiny of re­gional Fed­eral Re­serve banks.

Ques­tions have been raised about the lo­ca­tion of the re­gional banks and whether they should be more evenly dis­trib­uted around the coun­try and whether Se­nate con­fir­ma­tion should be re­quired of Fed­eral Re­serve Bank pres­i­dents. Some in Congress are an­gry be­cause the Fed won’t name the com­pa­nies par­tic­i­pat­ing in its pro­grams. And if the Fed gets new reg­u­la­tory pow­ers over the fi­nan­cial econ­omy, that will in­spire yet more at­tacks on its in­de­pen­dence.

Some ob­servers say the Fed al­ready has slipped over the edge po­lit­i­cally. The in­nu­endo in Ger­man Chan­cel­lor An­gela Merkel’s re­cent re­marks was telling when she said, “We must re­turn to­gether to an in­de­pen­dent cen­tral­bank pol­icy.”

The Fed’s po­lit­i­cal co­nun­drum has be­come deadly se­ri­ous, and the stakes are high. Fed Chair­man Ben S. Ber­nanke knew the risks when he and his col­leagues on the Fed­eral Open Mar­ket Com­mit­tee (FOMC) em­barked upon a bold new scheme to un­lock credit flows, but they be­lieved the risks were un­avoid­able. Fi­nan­cial mar­kets were frozen, the econ­omy was in deep trou­ble, and the Fed pol­i­cy­mak­ers be­came con­vinced that bold new pro­grams were es­sen­tial to pro­vide liq­uid­ity and stim­u­late eco­nomic growth.

Al­most overnight, the macroe­co­nomic Fed be­came the mi­croe­co­nomic man­ager, in­volv­ing it­self in the des­tinies of in­di­vid­ual busi­nesses, such as Bear Stearns Cos. Inc., Mer­rill Lynch & Co. Inc., Amer­i­can In­ter­na­tional Group Inc. and Cit­i­group Inc. Did the Fed go too far? Some an­a­lysts say yes and ar­gue that at least part of the Fed’s cleanup work could have been han­dled by the Trea­sury Depart­ment.

There’s no ques­tion: Politi­ciza­tion of our na­tion’s cen­tral bank will se­ri­ously dam­age the ef­fec­tive­ness of mon­e­tary pol­icy, the very heart and soul of the Fed’s mis­sion.

Mem­bers of Congress and pres­i­dents are elected for rel­a­tively short terms and thus have short time hori­zons, but Fed pol­icy of ne­ces­sity is also based on long-term trends and goals. Imag­ine what would hap­pen if greater po­lit­i­cal con­trol over the Fed led to sus­pi­cions that the cen­tral bank was be­ing prod­ded to push up inflation to cheapen the dol­lar in or­der to ease an un­sus­tain­able rise in the fed­eral debt. Sus­pi­cion that the debt was be­ing mon­e­tized be­cause of polit- ical pres­sures would trig­ger a flight from the dol­lar and a sharp loss in its value, among other neg­a­tive out­comes. The fall­out would be dis­as­trous.

Mr. Ber­nanke has clearly said the Fed will not mon­e­tize the debt. That’s be­liev­able as long as he re­mains Fed chair­man. But his very dec­la­ra­tion may have pro­voked some in Congress to step up their cam­paign to limit the Fed’s dis­cre­tion and in­de­pen­dence.

From what is not be­ing said, one senses the Obama ad­min­is­tra­tion un­der­stands the risks of Fed politi­ciza­tion, or even its ap­pear­ance, and will stay clear of mak­ing in­roads into the Fed’s au­thor­ity. In­deed, the ques­tions be­ing asked about the mo­tives of leg­is­la­tors seek­ing to con­strain the Fed and where it might lead are rais­ing a specter that, iron­i­cally, puts pres­sure on the pres­i­dent to reap­point Mr. Ber­nanke — the im­age of in­de­pen­dence — as chair­man when his term ex­pires in Jan­uary.

Con­fi­dence in the fu­ture is a great as­set that adds strength to the ar­gu­ment that the Fed should adopt a pol­icy of ex­plicit inflation tar­get­ing, which Mr. Ber­nanke fa­vors. In ad­di­tion to its eco­nomic mer­its, long-term tar­get­ing would be self-pro­tect­ing.

Hon­est arith­metic tells us ex­pected eco­nomic growth in the next decade will be in­suf­fi­cient to bring pro­jected ra­tios of debt to gross do­mes­tic prod­uct down to ac­cept­able lev­els, so taxes will have to be raised and en­ti­tle­ment pro­grams cut back. Taxes alone can‘t be raised enough to re­duce the debt ra­tio without do­ing se­ri­ous in­jury to the econ­omy. Mem­bers of Congress know this. Thus, a par­tial back­door so­lu­tion, via the hid­den tax of higher inflation — if it could be blamed on the Fed — might seem to them an at­trac­tive choice.

How the Fed fares in the months and years ahead will de­pend very much on whether its new pro­grams and poli­cies prove ef­fec­tive. If they help save the day, there’s a good chance the Fed’s in­de­pen­dence will re­main in­tact. Let’s hope so.

Al­fred Tella is for­mer Ge­orge­town Uni­ver­sity re­search pro­fes­sor of eco­nomics.

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