Senator Rand Paul recently reintroduced his “Audit The Fed” legislation, now sporting 30 Senate co-sponsors. The bill is popular in some quarters, but it’s received some criticism over the past few days, not only from the White House, but also from some of the Fed’s most hawkish members and outspoken Fed critic Senator Elizabeth Warren (D., Mass.).
As a former Fed employee who is familiar with the generally mundane inner workings of monetary policy, I’m shocked that Paul’s effort has grown in popularity. It unfairly assails the country’s central bank for political gain at the potential cost of policy independence — exactly the opposite of good monetary policy.
The Fed in fact already has several audits in place, which are convened by the Government Accountability Office and the Fed’s inspector general to ensure that institutional money in the Fed’s liquidity programs and other operations is accounted for.
An “audit” of the Fed of the sort that Rand Paul’s bill proposes is redundant and would hinder the Fed’s ability to communicate its stance on monetary policy.
The purpose of a traditional financial audit is to identify accounting irregularities, with the goal of thwarting fraud, embezzlement, and money laundering. Unlike commercial banks, which have scores of individual clients whose accounts require thorough audits, central banks such as the Federal Reserve house a limited number of interest-paying accounts for institutions that use the Fed’s liquidity programs. The political purpose of the “Audit the Fed” bill is, rather, to audit the monetary-policy statements issued by the Fed, in the hope of gaining not just more transparency in Federal Reserve policymaking, but also more influence for Congress over monetary-policy decisions.
However well-intentioned the desire for government transparency is, this proposal is ultimately a dangerous threat to central-bank independence, a principle crucial to the effectiveness of monetary policy.
Financial markets and economic forecasters scrutinize every word in statements by individual Federal Reserve officials and the joint Federal Open Market Committee (FOMC). There have been tense internal debates between Fed officials over the use of specific words and phrases (for example, whether the Fed should be described as “patient,” and whether there will be a “considerable time” before interest-rate hikes will commence).
Such Fed statements are incredibly powerful — they set interest-rate expectations and ultimately reduce the cost of borrowing, which has helped the U.S. economy recover from past economic collapses.
New “audits” forcing the Fed to disclose private e-mails and other correspondence between Fed officials could add unnecessary volatility to financial markets. If the past few years have taught us anything about financial markets, it’s that central-bank statements can cause immediate shocks (both positive and negative) to financial markets.
Critics of quantitative easing demand to know where the Fed is buying the long-term assets needed for the program, but the Fed has already told us the answer. It buys bonds from the 22 primary dealers who are publicly listed.
Any further information on exact timing and quantities of bonds purchased from individual banks could create opportunities for traders to exploit this information and profit from the Fed’s traders and the banks who have sold securities to the Fed. This is the same reason private banks do not disclose their trading records beyond their profit-and-loss statement.
Moreover, the Federal Reserve has already made several steps in recent years toward promoting the transparency of its monetary-policy decisions.
Since 2008, the Fed has published federal-funds-rate forecasts known as “forward guidance,” which indicate the Fed’s stance on future monetary policy (contingent on the economy’s meeting certain targets on unemployment, GDP, and inflation). In 2011, Ben Bernanke held the first Fed press conference in history, creating a new forum for the Fed chair to take questions from all types of financial journalists.
In 2012, the Fed announced that it was adopting the “Evans Rule,” which stated that the Fed would not begin raising interest rates until unemployment fell below 6.5 percent or inflation went above 2.5 percent, and in 2014, the Federal Reserve Board of Governors made its standard model of the economy available to the public.
Certainly, more could be done to further Fed transparency. While the Fed is unlikely to go as far as to bind itself to a mathematical monetary-policy rule such as the one advocated by Stanford economist John Taylor, it could move toward earlier releases of some of its FOMC monetary-policy memos (such as the “Bluebook,” which contains a number of monetary-policy rules and “policy alternatives”), currently published at a five-year lag.
Last, requiring the Fed to make a substantial amount of public disclosures and deliver congressional testimony explaining monetary-policy decisions could create outsized political influence on the Fed – whoever happens to be in charge of Congress.
At one extreme, overt Democratic influence on the Fed could lead to a monetization of federal debt, “helicopter money” that would finance fiscal deficits, or a generally much more accommodative monetary policy (which results in “higher inflation and bad economic outcomes,” according to former Fed governor Jeremy Stein). At the other extreme, overt Republican influence on the Fed might lead the country back to a gold standard, which can hinder economic growth by diminishing the money supply (as evidenced by Ben Bernanke’s research on the Great Depression).
Arguably, in recent years, the Fed has already become more politicized. In 2013, a grassroots Democratic effort lobbied against former Harvard president Larry Summers’s candidacy for the Fed chairmanship, ultimately prompting him to withdraw interest, making way for Janet Yellen, an ostensibly more dovish candidate.
Rather than try to create a politicized “audit” of the Fed, Congress should spend more time working on policies that can boost the economy and that fall under its powers: trade deals such as the Trans-Pacific Partnership and serious tax reform, including a reduction in the abnormally high U.S. corporate-tax rate.
Congress’s time, in other words, could be much better spent on pro-growth strategies than on counterproductive investigations of the Fed.
— Jon Hartley is an economics contributor for Forbes and the co-founder of Real Time Macroeconomics LLC, a financial-technology firm. You can follow him on Twitter at @Jon_Hartley_