Democratizing The Fed Or Politicizing Monetary Policy?

The British historian Lord Acton famously said that “power corrupts and absolute power corrupts absolutely.” The American response is a system of checks and balances. The Federal Reserve represents a concentration of power that became abundantly clear during and after the Great Financial Crisis.  

The Federal Reserve is a creation of the legislature, not the Constitution. Congress is trying to reassert its control. The latest reports indicate that the Republicans, which enjoy a majority in both chambers, will call for a vote tomorrow on the Fed Oversight Modernization and Reform Act. 

There are three measures in the bill that have in particular raised the ire of the White House and Fed Chair Yellen.  First, the bill requires that the Fed a mathematical formula, like the Taylor Rules, to set short-term interest rates. Second, the bill would limit the emergency powers that the Fed claimed during the crisis. Third, the bills require the Government Accountability Office to review monetary policy decisions.   

Each of these measures is flawed.The bill, which is originating in the House of Representatives, is unlikely to pass. And if it does pass, Obama is likely to veto the measure. Obama has used his veto powers sparingly. He has exercised the veto around five times.The least since Warren Harding in the 1920’s. However, the underlying issue will not go away. There may be other attempts to check the Fed’s power. 

The idea that the conduct of monetary policy can be driven by a simple agreed upon rule is farcical. It is true that as House Speaker Ryan said, “At times when the Fed apparently practiced a rules-based monetary policy, the US, and global economies grew with low inflation.” The key words are “at times” and “apparently”. The former gets to the idea that there are other times when faced with unprecedented conditions, the Fed correctly must innovate.