Some conservative lawmakers have been arguing for years that Congress should audit the Federal Reserve and take a more active role overseeing monetary policy. Now that the GOP is in full control of the Capitol, the issue has taken on new urgency—as Fed Chair Janet Yellen learned last month during a combative hearing with senators.
The argument goes that the depth and length of the recent recession, the slow pace of recovery, the Fed’s failure to prevent the crisis in the first place, and its unconventional responses all support the view that it needs more oversight. The central bank’s independence, they say, isn’t doing the trick.
Nothing could be further from the truth. It betrays a misunderstanding of what it means for a central bank to be independent and how monetary policy is crafted and carried out.
In my 20 years working at the Fed, first in New York where I helped implement monetary policy on the trading desk and then in Atlanta as the senior officer in charge of research, I learned that dealing with the unexpected is the day-to-day reality of the job. And it’s best if your hands aren’t tied.
If the Fed loses its independence, then its policy will become less sensitive to what’s going on in the real world and more of a hostage to people who know far less about designing and implementing monetary policy. That would be a significant step backward.
What Fed ‘Independence’ Really Means
Social scientists of all political persuasions no longer even debate the question of whether the central bank should be “independent.”
They recognize the term refers only to how policy is implemented—free of political pressure—and that independence does not give the central bank the ability to set its own goals, as some lawmakers seem to think.
In fact, Congress has established various mandates for the Federal Reserve to follow since the latter’s creation in 1913. And central bankers place public interest at the center of their deliberations when carrying out monetary policy.
At present, the Fed follows a dual mandate of keeping inflation within its target range of around 2 percent while maximizing employment. Congress set these goals, but the Fed itself needs the freedom to choose which instruments it employs to meet them.
A good analogy is building a house. The owner takes part in drafting the plans but doesn’t worry which type of hammer is used. Similarly in an operating room, the surgeon must be able to quickly choose which scalpels and other instruments will help her save the patient (in the Fed’s case, the U.S. economy). While she follows the guidelines learned in medical school and past clinical experience, there is no time for excessive deliberation when someone’s life is on the line.
Monetary Policy Is Neither Simple Nor Fixed
The demand for an audit rests on the notion that there is a simple way to carry out monetary policy, as if there were one rule to follow. In the economics profession, the discussion of sticking to policy rules has quieted down as we learned, over and over again, that constant changes in the way people and companies behave and continuous innovation undercut the foundation for rigid rules.
For example, during parts of the ’70s and ’80s, the Fed tried a “money supply rule” that aimed to keep the expansion of currency in circulation and bank deposits within a range of growth rates.
At first it looked as if this would work well. That is until everyone could “create money” on a whim by using a credit card. Whenever you use credit to buy a new computer or pay for groceries, you’re getting a bank to lend you “money” that did not exist a second ago but suddenly does once the transaction clears. It did not make sense to target something that could not be controlled with precision.
The rule was fortunately phased out during the 1990s. Similar rules such as the gold standard and fixed exchange rates also bit the dust, but in the process caused considerably more economic upheaval.