Photo courtesy of iStockphoto.
The House of Representatives, in a strong vote of 327-98 (Peterson, Hughes), recently passed Texas Congressman Ron Paul’s bill to audit the Federal Reserve (Fed). Despite the huge popularity in the lower chamber, Senate Majority Leader Harry Reid has tabled the bill, suppressing debate and preventing a vote on the legislation. Paul supporters and opponents of the Fed were jubilant regarding the large majority of votes in the House, but outraged that it was so easily stalled in the Senate. The statute, if passed, would require an audit of the Fed’s monetary policy deliberations and decisions, to be conducted by the Government Accountability Office (GAO), leading to further legislative recommendations. I was pleased to see Senator Reid table the bill, and I think this is a responsible action for a Senate Majority Leader. My stance may seem perplexing to many people though, so it requires some explanation. My trepidation about the audit the Fed legislation is that the underlying intention is central bank termination, under the cover of policy examination.
A majority of Americans polled in 2010 had the view that the Fed should be reigned in politically or abolished. About 39% believe that the Fed should be more accountable to the people, while 16% wanted to eliminate the central bank altogether (Zumbrun). Polling conducted a year later in December 2011 found that the investment community had a much different assessment of the Fed’s performance. Chairman Ben Bernanke had a high 71% approval rating amongst investors, who also believed that the Fed is outperforming the European Central Bank (ECB) on monetary policy (Dorning). It seems that those with more experience in financial matters tend to embrace modern monetary institutions to a greater extent than the layperson. Nevertheless, even those who agree with central banking in principle may not be happy with particular Fed policies and actions. These days everyone is a critic. Resentment of the Fed can come from the left and the right of the political spectrum, although for different reasons. The most outspoken critics are former GOP Presidential candidate Ron Paul and his followers. The call for transparency is loudest amongst those who really want to “End the Fed!” My fear is that this sentiment behind auditing could lead to a curtailment of central bank independence, with greater political influence over monetary policy in the future. This is a bad thing.
The Argument for Central Bank Independence
Auditing the Federal Reserve under the auspices of increasing transparency places central bank independence at risk. Chairman Ben Bernanke called this a “nightmare scenario”, explaining that “what the Audit the Fed bill would do would be to eliminate the exemption for monetary-policy deliberations and decisions from the GAO audit. So, in effect, what it would do is allow Congress, for example, to ask the GAO to audit a decision taken by the Fed about interest rates.” (Glyn) This would negatively compromise monetary decisions, because it would injection political supervision and consideration into deliberations. Noah Glyn, at the conservative National Review agrees with this assessment from Bernanke, recognizing that even though Ron Paul and other conservatives may have the right intentions with their own policy views, opening the door to political influence cuts both ways, giving liberal policy makers more control as well. This could lead to very bad outcomes, and the historical record suggest that this is far too likely.
Michael Salemi, the Department of Economics Chair for North Carolina University at Chapel Hill has filmed a Great Courses series on money and banking for The Teaching Company, which covers the economics of financial markets. It’s an insightful 36 lecture ensemble, including one full lecture devoted to the arguments for central bank independence. He explains the theoretical underpinnings of the argument for independence, as laid out in an influential paper by economists Robert Barro and David Gordon, and then Salemi backs up this theoretical argument with empirical cross-country analysis from economists Alberto Alesina and Lawrence Summers, as well as an analysis of the evolution of central bank independence taken from the research of Christopher Crowe and Ellen Meade. Salemi’s lecture also touches on the issue of central bank transparency. I highly recommend this lecture series for anyone who is interested in expanding their understanding of monetary economics, it has been a great supplement to my earlier education on the subject.
In 1983 Barro and Gordon provided a sound theoretical foundation for the conclusion that there is an inflation bias when central bank independence is compromised by greater political influence. This argument is premised on the Phillip’s Curve, an observed trade-off between unemployment and inflation, such that a rate of unemployment which is held below the natural rate of unemployment will also drive up the inflation rate. When political regimes have more control over central banks their tendency is toward lowering unemployment for short term political purposes, and this creates the inflation bias. Central bank independence is needed to hedge against inflation bias. Salemi depicts Barro’s and Gordon’s theory with two equations, one of Phillip’s Curve derivation, the second a loss function that formalizes the impact of political influence (Salemi). In 2012, Fed Chairman Ben Bernanke has recently resisted expectations that the central bank might inject further monetary stimulus into the economy, a third round of quantitative easing, while leaving the door open to future stimulus should macro conditions unequivocally deteriorate. Bernanke is certainly not pumping money into the system in order to help the President, and the fear of appearing political might even be holding the Fed back from stimulus they might otherwise engage in. What would happen if the executive branch had direct control over Fed decision making? What about the Congress?
There is empirical support for the inverse relationship between central bank independence and inflation bias, such that the more independence the greater tendency to low rates of inflation. In 1993 Alesina and Summers developed an index to measure central bank independence, and they assigned an index number to various countries, placing them on a scale from lesser to greater political control. Then they compared these index ratings to average rates of inflation between 1955 and 1988, finding a clear inverse correlation between central bank independence and high inflation, as well as central bank independence and inflation variability. In this analysis the U.S. is shown to have strong central bank independence with low and steady rates of inflation, in comparison to other developed nations, and the Fed gets high marks for responsible monetary policy during this period (Alesina, Summers) (Salemi). This good performance from America’s central bank would be placed in jeopardy with an audit designed to question and critique policy deliberations and decisions.
The research of Crowe and Meade provides additional support for Salemi’s assessment of central bank independence. Crowe and Meade measured independence using four criteria: (1) appointments must be independent and tenures secure, thus reducing political pressure on monetary managers, (2) the government does not direct, veto, or repeal policy decisions, (3) policy objectives are mandated specifically, (4) and the degree to which central banks have financial independence for operations, including independence over direct government lending. The researchers looked at data from 72 countries since 1980 and found that inflation has moderated across the spectrum in conjunction with a concerted move toward establishing more central bank independence (Crowe, Meade). In fact, the U.S. has become less independent in relation to other countries during this time, due to the dual mandate. This has in effect removed the inverse correlation discovered by Alesina and Summers, and suggests the wisdom of prescribing central bank independence (Salemi). If the U.S. actually takes legislative steps to curtail monetary policy autonomy, then we would in effect be moving backward in a direction that the rest of the world has abandoned to their great benefit.
Back in 2009, in commentary regarding an earlier but similar Fed transparency bill introduced by Ron Paul, conservative columnist James Pethokoukis asked six economists what they thought about Paul’s crusade, and the responses were less than enthusiastic. Robert Shiller of Yale University, and co-creator of the Case-Shiller housing price index said, “The GAO audit proposal is from Ron Paul, who has advocated abolishing the Fed and returning to the gold standard. Maybe people think that this is his foot in the door, a first step in the plan. When King Louis 16 called for a meeting of the Estates General in France, it led to a chain of events that resulted in his beheading!”
Lee Ohanian of UCLA explained, “An important reason why so many economists argue for independence is because there is substantial cross-country evidence that Central Banks which are more closely tied to the legislature have much higher inflation rates than in highly independent Central Banks.”
James Hamilton of UC-San Diego replied, “My own concern is not about a specific step such as a proposed audit but rather is a response to what I see as a changing political climate in which I fear it will be more difficult for the Fed to withstand pressure to monetize the deficit.”
Anil Kashyap of the University of Chicago stated, “The spirit of the Paul bill seems to be that having FOMC meetings live on C-SPAN would be best way to make monetary policy. That would be a disaster….You want people to be able to change their mind and to be able to vigorously debate all sides of an issue. If you put all this in public and subject to immediate second guessing it will shut down the give and take that is critical to reaching good decisions.”
Michael Woodford of Columbia University suggests, “The only purpose of the new bill is therefore to decrease the Fed’s independence with regard to monetary policy decisions. Considerable historical experience suggests that political interference with monetary policy decisions can lead to regrettable outcomes — which is why Congress itself decided to forswear such interference.”
Michael Feroli of JPMorgan argued, “For one, that could stifle the openness of the debate: to take an example, the Chairman always has to dance around the issue of NAIRU because it can be misperceived by economically illiterate members of Congress as meaning the Fed wants to engineer a certain amount of unemployment…. With audited conversations, the debate could become stilted. I think a GAO audit would also risk appearing as an official verdict on Fed decisions, as opposed to twenty different Congressmen questioning the Fed, which is much more clearly the opinions of some politicians.”
Supporters of auditing the Fed have latched onto a YouTube video of Senator Harry Reid giving a speech on the Senate floor in 1995, in which he is making a case that the central bank should be audited. This is an example of Reid flip-flopping on the issue, now that he has refused to even consider the recent legislation passed in the House. In the video clip Reid is concerned about the negative consequences on business and citizens from the Fed raising interest rates, and he infers the need for the Fed to produce a report that explores and explains these negatives. This is exactly the sort of political pressure that I think needs to be protected against, the kind that leads to inflation bias. So, rather than selling me on Ron Paul’s agenda, this Harry Reid speech from 1995 makes me even more skeptical about audit the Fed. I agree with the 2012 Majority Leader Harry Reid, not the younger 1995 version of the Senator, so I am happy to see this flip-flop.
Senator Reid and economists who support Fed independence are often referred to as apologists, insiders, hacks, shills, and supporters of the Fed are sometimes insinuated to have ulterior or selfish motivations. These ad-hominems are common from Ron Paul supporters, many who take to certain conspiracy theories about the Fed and take it as given that the institution is evil, corrupt, and completely unnecessary. There is much to be concerned about with central bank independence, and accusations by Fed opponents, no matter how conspiratorial, could still have merit. My education is also in political science, so I am quite familiar with our Founding Father’s concerns regarding concentrations and centralizations of power, I get that there is agency capture, and I subscribe to theories like Michel’s Iron Law of Oligarchy, which suggests that institutions tend toward control by, and for, elite self-interests. Nevertheless, I find the arguments and evidence above to be more pragmatically compelling, the risks of losing central bank independence outweigh the costs of central bank autonomy.
The Virtues of Transparency
I do not want to give the impression that I am arguing for a Federal Reserve that is supremely elite, unaccountable, and utterly opaque. Not at all. In fact, I am all for greater transparency at the Fed, I am just opposed to a situation which will lead to greater political control. Consider that the Fed is already audited and has significantly increased transparency over the decades in responsible ways. First, the Fed’s balance sheet is updated weekly and available on the web, along with a host of other statistical and research data. The GAO monitors the Fed, and recently audited the Fed’s lending activity during the Great Panic of 2008, per the Wall Street Reform and Consumer Protection Act, which is incidentally the same audit that the six economists cited above were arguing against. The Office of Inspector General (OIG) provides an outside auditor to verify legal and regulatory compliance, and along with the GAO audits these are provided in the Board of Governor’s annual report. Another independent audit of the Fed’s financial statements is conducted by an outside firm (“Does the Federal Reserve…”).
In relation to each meeting of the Federal Open Market Committee (FOMC) there is publication of the Beige Book, the Greenbook, and the Bluebook. The Beige Book is the “Summary of Commentary on Current Economic Conditions by Federal Reserve District,” the Greenbook covers “Current Economic and Financial Conditions,” and the Bluebook is “Monetary Policy Alternatives.” Combined these analyses supply a considerable context within which policy decisions are made. The minutes from FOMC meetings are released three weeks after policy decisions, and include the rationale behind any actions taken. Since 1994, the full meeting transcripts have been released with a five year delay (“Transcripts”), a change that is believed by some to have already led to less forthrightness and less expression of dissent during FOMC discussions (Salemi). In the spirit of improving transparency even further, Bernanke has began holding regular press conferences as well as publicizing the Fed’s interest rate forecasts for the next three years (Peterson, Hughes). This is on top of the regular grillings that Fed officials receive from the relevant committees in the Congress, often dramatic oversight hearings that can be watched on YouTube, complements of the 1978 Humphrey–Hawkins Full Employment Act.
Transparency should actually be a goal of monetary policy according to modern theory. This is because a well telegraphed monetary policy has the effect of reducing uncertainty about where interest rates are likely to be headed. The reduction of uncertainty is helpful for short and long term planning, creating the conditions for economic growth, greater employment, with low and steady inflation. These are macroeconomic goals that the Fed sets ouch to achieve under their dual mandate of price stability and full employment, rules also established by Humphrey–Hawkins. The relatively recent Fed policy to become more transparent with regard to various macroeconomic forecasts, under which interest rate targets are decided, is part of its Enhanced Communication Strategy under Chairman Bernanke. In 2007, to an undergraduate class at MIT, then Federal Reserve Board Governor Frederic Mishkin explained the monetary science that supports the move toward transparency:
The modern approach to the formulation of monetary policy is generally characterized by an optimization problem in which policymakers maximize a specific objective function subject to a set of constraints. At first glance, this problem looks a lot like the typical optimal control problem that MIT undergraduates might study in an engineering course–say that of directing a rocket ship to the moon. However, there is a crucial difference: A rocket ship responds only to forces currently acting on it and does not try to anticipate how its controllers will change their settings. In contrast, expectations about future monetary policy and economic conditions play a key role in economic agents’ decisions and thus are important in both the objective function and the constraints of the optimal monetary policy problem. This role of expectations is crucial in understanding why central bank communication is so important for achieving good macroeconomic outcomes…. I have argued that the Federal Reserve’s enhanced communication strategy will improve the public’s understanding of our objectives and policy strategies and thereby enable households and businesses to make better decisions. In addition, enhanced communication can help anchor the public’s inflation expectations, which promotes both price stability and higher economic growth. As we have seen, the new communication strategy is consistent with what the modern science of monetary policy suggests is needed to achieve good monetary policy outcomes. (Mishkin)
I listen to CNBC during my morning and afternoon commutes, a channel that gives great fanfare to any news involving the Fed or information from the FOMC. Commentators and analysts break down every statement from Chairman Bernanke, looking for the slightest indication that there has been a change in wording, leaving Rick Santelli, Steve Liesman, and the like, to debate the ramifications. I follow the Fed as much as I can, being more keenly interested than most, and perhaps this regular attunement to financial news and Fed coverage has compromised my antipathy toward central banking. I just don’t feel that far in the dark in regards to Federal Reserve prerogatives and operations, nor am I suspicious of the activities that they carry out. In my assessment, the Fed has performed a remarkable job since 2008 under Bernanke’s leadership, taking many extraordinary steps to address extraordinary problems. I like the idea that the Fed is enhancing its own communications and transparency per consideration of monetary science, an approach that would likely be disregarded by the push and pull of Congressional intervention under cover or intention of transparency.
Paulites and Libertarians are not the only ones to take issue with the Fed. Nobel Prize winning economist Joseph Stiglitz has expressed the sentiment that the Fed’s structure creates so many conflicts of interest that he thinks it is “corrupt”. He said that when he was heading the World Bank they would not have dealt with any countries that had central banking set up the way America does it. He dialed back on his comments later, saying maybe it was a “little hyperbole”, but maintains that the governors of the regional Fed banks should not be selected in a way that causes the banks to regulate themselves, as is currently the case (Nasiripour). Stiglitz surely knows what he is talking about, the structure of the Fed is uniquely American, a combination of both public and private interests by design, with the ultimate power over monetary policy weighted in favor of the public appointees. The regional Reserve Bank presidents are selected from the private banking sector, and this method spreads federal power geographically, and consolidation of all appointment power to the U.S. President could have the counterintuitive effect of centralizing authority, and jeopardize the intended system of local representation and regional diversity within the current structure (James). Conflicts of interest, even the appearances of them, are not good for monetary policy, and perhaps an audit would uncover issues where the conflicts actually resulted in suboptimal choices, but I see the loss of Fed independence as a greater risk if we attempt to re-legislate the governing structure at this moment in time.
But isn’t more transparency always a good thing? America has strong democratic values and the idea that public officials are answerable to the people is sacrosanct. The Federal Reserve System is headed by governors who are unelected, appear elite and unaccountable, and sustain close relationships with the high lords of banking and finance, a suspicious situation to many Americans in these trying times of financial discredit. Chairman Bernanke has initiated many unprecedented policy actions, maintaining interest rates at record low levels for a record amount of time, extraordinary emergency lending from the discount window, tripling of the Fed’s balance sheet, absorption of toxic assets, quantitative easing, operation twist, and you get the picture. Don’t the American people have a right to an audit of the meetings and deliberations that led to these policy decisions, and an assessment of this wisdom from an independent authority? Is not sunlight the best disinfectant? Sure we can trust, but shouldn’t we still verify?
In February, my wife and I visited New Orleans for Mardi Gras, where we had a wonderful time enjoying the fruits of American freedom, and in celebration of the trip I wrote a couple articles on liberty. My thesis in the second article, ”The Liberty of Anonymity”, is that freedom to act is enhanced under lack of transparency by changing the consequences of acting, such as when one dons a mask at Mardi Gras. In my article I talked about the fabled Ring of Gyges, as discussed in Plato’s dialog Republic, a ring of invisibility that enables and encourages the wearer to disregard justice, an invitation to flaunt law, morale, and custom. Lack of transparency is not necessarily a bad thing, notably essential in situations we take for granted such as espionage, but it does present a kind of paradox for public officials. The freedom to act in secret can hide illicit, unsavory, self-serving, and inept actions. However, there is another side to the transparency coin, the freedom of honest experts to act for the public good when the actions needed might otherwise be influenced by politics, with crowds of agitated laypeople steering the ship rather than the studied professionals who have the expertise needed. This democracy problem is summed up by another metaphor from Plato’s Republic:
Imagine then a fleet or a ship in which there is a captain who is taller and stronger than any of the crew, but he is a little deaf and has a similar infirmity in sight, and his knowledge of navigation is not much better. The sailors are quarreling with one another about the steering –every one is of opinion that he has a right to steer, though he has never learned the art of navigation and cannot tell who taught him or when he learned, and will further assert that it cannot be taught, and they are ready to cut in pieces any one who says the contrary. They throng about the captain, begging and praying him to commit the helm to them; and if at any time they do not prevail, but others are preferred to them, they kill the others or throw them overboard, and having first chained up the noble captain’s senses with drink or some narcotic drug, they mutiny and take possession of the ship and make free with the stores; thus, eating and drinking, they proceed on their voyage in such a manner as might be expected of them. Him who is their partisan and cleverly aids them in their plot for getting the ship out of the captain’s hands into their own whether by force or persuasion, they compliment with the name of sailor, pilot, able seaman, and abuse the other sort of man, whom they call a good-for-nothing; but that the true pilot must pay attention to the year and seasons and sky and stars and winds, and whatever else belongs to his art, if he intends to be really qualified for the command of a ship, and that he must and will be the steerer, whether other people like or not-the possibility of this union of authority with the steerer’s art has never seriously entered into their thoughts or been made part of their calling. Now in vessels which are in a state of mutiny and by sailors who are mutineers, how will the true pilot be regarded? Will he not be called by them a prater, a star-gazer, a good-for-nothing? (Plato, Republic, Book VI)
The Fed is an elite institution with incredibly powerful influence over our economic lives. In many ways it is undemocratic. I am a supporter of democracy, but I also take Plato’s warning about mob rule to heart. Highly technical matters regarding economic policy ought to be elite, and just as we trust in nine unelected Supreme Court Justices to be the final arbitrators for our legal institutions, we should trust our monetary policy to monetary experts. If the rising clamor for an audit of the Fed leads to greater political involvement in policy it will be akin to the scenario described by Plato, in which a crew untrained in navigation mutinies on the much more experienced and knowing captain. The chances of getting lost at sea will have increased. The chances of wrecking into the shoals will be greater than before.
The Transparency Trojan Horse
Ron Paul is the most salient force behind the movement to the audit the Fed. However, deep down inside Paul has made up his mind that the Fed needs to be dismantled. In fact, it’s not deep down inside, it’s quite blatant given that Ron Paul has published a book on monetary policy called End the Fed, a reference to a slogan chanted by his supporters at presidential rallies in 2008 and since. Transparency and audits are part of a larger effort to completely abolish the central bank. Ron Paul versus Ben Bernanke is the former’s chance to live the fantasy of channeling President Andrew Jackson’s fight against Nicholas Biddle and the Second Bank of the United States.
I should know. I was elected as an alternate delegate to the Washington State Republican Party Convention in the Spring of 2008, representing Ron Paul and coalescing with the many like-minded people I found there. Antipathy towards central banking and the Fed was a sentiment I shared at the time, when most of what I knew about the Fed came from Ron Paul himself, reading Austrian School economics, reading The Creature From Jekyll Island, watching a documentary called Monopoly Men, listening to the Alex Jones Radio Show, and various other conspiracy oriented media. However, my views began to change when I took a class on money and banking in the Fall of 2008 whilst pursuing a deeper economics education for my work as a forecaster in finance and budgeting. Despite my evolution of viewpoint away from end the Fed the general populace may be moving in the opposite direction. Consider that this excerpt from Paul’s book is a growing sentiment among young American’s who’ve become distrustful of banking:
I’ve always been an optimist about the cause of sound money, but even I never imagined that the anti-Fed cause would become material for popular protests in my lifetime. All around the country, people are gathering outside Federal Reserve buildings to protest against the power, secrecy, and operations of the Fed, and chanting this great slogan. Their goal is not reform but revolution: an end to the Fed…. It is and should be a mainstream cause to end the power and secrecy of the Fed. It’s my own view that ending the Fed would address the most vexing problems of politics of our time. It would bring an end to dollar depreciation. It would take away from the government the means to fund its endless wars. It would curb the government’s attacks on the civil liberties of Americans, stop its vast debt accumulation that will be paid by future generations, and arrest its massive expansions of the welfare state that has turned us into a nation of dependents…. (Paul 6-8)
Ron Paul’s Federal Reserve Transparency Act is Trojan Horse legislation that seeks to compromise Fed operations. The bill instructs the Comptroller General to conduct an audit and create a report that “shall include a detailed description of the findings and conclusion of the Comptroller General with respect to the audit that is the subject of the report, together with such recommendations for legislative or administrative action as the Comptroller General may determine to be appropriate.” (H.R.459) This is the foot in the door for greater political control, for monetary policy to become driven by agendas instead of economics. And Ron Paul’s intentions should be clear to anyone who pays attention to him. Since at least 1999 Paul has been introducing the Federal Reserve Board Abolition Act which states, “To abolish the Board of Governors of the Federal Reserve System and the Federal reserve banks, to repeal the Federal Reserve Act, and for other purposes.” (H.R. 1094) Even if you agree with his intentions, he is opening the door to changing the status quo in ways that he won’t have individual control over, and this increases the chances that monetary policy will be used to push unemployment below the natural rate, and to monetize the national debt. Although the Congressman is retiring after the current session, the Tea Party movement and Campaign for Liberty are likely to continue to demagogue the Federal Reserve along with other government institutions, and this is a clear and present danger to the Fed’s independence.
Conspiracy Theories and Additional Concerns
Conspiracy theories and anti-Fed propaganda is all over the web these days, some of it partially true, some of it nonsense, and the misconceptions and mythology surrounding an institution in existence for almost a century has a lot to do with its opaqueness, but also ignorance. Much of the suspicion surrounding the Fed is fueled by conspiracy theories pushed by demagogues. There is legitimate arguments against central banking, such as the Austrian School Theory of the Business Cycle, which holds that artificially controlled interest rates and fiat money lead to the booms and busts of the business cycle, amongst many other problems. I do not subscribe to much of this theory myself, finding it less compelling in relation to other financial and monetary theories, but it is reasonable, worth consideration, and should not be written-off (I’m admittedly glossing over the Austrian complaints, but this is because I want to cover those separately, at some point). However, there are all sorts of paranoid insinuations about the Fed that I find incredibly spurious, some of which I have covered in the past. In the article, ”The Federal Reserve Conspiracy Tapestry Torn,” I addressed the theory that the Panic of 1907 was orchestrated by bankers such as J.P. Morgan, with the purpose of priming the public for a central bank, as well as claims that the Fed is a for-profit cartel completely outside of public control.
Attackers of the Fed often decry the long term devaluation of the dollar under the Fed’s fiat money regime, inferring that it represents a loss of real wealth with claims like, “the Fed has destroyed 96% of the dollar’s value since 1913 and pretty soon it will collapse.” The data I considered in my article, ”The Changing Value of Money”, demonstrates the fallaciousness of these dollar devaluation arguments. Real wealth has increased for all income classes since I was born in 1976, and the increase of nominal prices has been more than compensated by the increase in nominal income. I also touch on monetary policy in relation to price inflation in two annual Thanksgiving specials, ”Thanksgiving Dinner and Inflation Forecasts” and ”Inflation and the Cost of Thanksgiving Dinner”. Additionally, I discussed the problems with generally falling prices in ”The Case Against Deflation”. Fed abolitionists typically view inflation and deflation in much different terms than Fed advocates, and my views in these articles are those of the Fed advocate.
Conclusion
Economist William Barnett, a previous Federal Reserve insider, agrees that an audit does present dangers to Fed independence, but contends that it is nevertheless still better than the status quo. Political pressure is already placed on the Fed, and in the past it more often came from the executive branch, so an audit would not be as significant an incremental shift as the insiders are worried about. The main reason for an audit, according to Barnett, results from the fact that the integrity of the data used by the Fed decision makers is less than desirable. Those in charge of policy also influence the data that is used, and this creates another conflict of interest. He suggest that the optimal solution would be to forego the audit, preserve autonomy for monetary policy, and create an independent institute for monetary and financial data for the Fed to utilize (Barnett).
Noah Glyn argues that instead of an audit that could compromise independence we should just change the Fed’s mandate so that it is bound to a certain policy rule. It could be the Taylor Rule, named for John Taylor of the Hoover Institution, a formula for determining monetary policy based on a balancing of the inflation and employment outlooks, or it could even be Milton Friedman’s old K Percent Rule, in which the money supply is automatically grown at some fixed rate (Glyn). If I’m not mistaken, Congressman Paul Ryan, Governor Mitt Romney’s shiny new running mate in the Presidential race, has argued that we should remove the Fed’s dual mandate and require it to focus solely on price stability, and not on unemployment at all.
I support some forms of transparency at the Federal Reserve, when it enhances the predictability of policy actions, but I am opposed to the kind of transparency that trades economic considerations for political considerations. I am open to addressing concerns about the Fed’s practice of allowing the regulated banks to handpick their own regulators, sharing the concerns of Stiglitz about the conflicts of interest that this entails. I would seriously entertain the idea of updating the Fed’s dual mandate to make the Taylor Rule part of its instructions, as this would provide more predictability, yet I think that even in this case there should be exceptions which allow for discretionary action should we find ourselves in the midst of another financial crisis. I like Barnett’s idea of an independent monetary research institution. What I don’t agree with is an audit that serves to discredit the Fed’s policy decisions in order to abolish this century old institution. It is my conviction that we would be economically worse off today if we were without a central bank, and I believe that Ben Bernanke has done an outstanding job as Chairman. If Ron Paul was to get his way and we were to “End the Fed” my forecasts for the economic future would grow more pessimistic.
Congressman Ron Paul often invokes the spirit of President Thomas Jefferson and the Constitution in his crusade to abolish the Fed, so I will invoke a founders story that illustrates a monetary reform suggestion of my own. James Madison drafted the Bill of Rights for the Constitution, but like Alexander Hamilton and other Federalists he was originally opposed to the idea. The Federalist Papers advanced arguments against a Bill of Rights, suggesting that enumerated rights would only limit civil liberties, something I covered in ”The Conundrum of the Ninth Amendment.” However, the Federalists had another strong motivation for opposing a Bill of Rights, because it was being agitated for by the Anti-Federalists, who’s goal was to prevent ratification of the Constitution altogether.
The Bills of Rights that were being proposed by the Anti-Federalists were written in ways that would annul the powers in the Constitution , a Trojan Horse method that would undermine the new federal authority before it was even instituted. When Madison realized that there was widespread sentiment for a Bill of Rights amongst the populace at large, and that it would be needed for ratification, he agreed to one, then drafted it himself so that it would not derail the powers in the Constitution (Pangle). This is what I think America’s monetary economists need to do. The Fed should have a convention of economists, broadcast the debates on the internet or on C-SPAN, vote on the best reforms, and then implement changes from the inside to great fanfare. My suggestion might not be practical, but just as Madison preserved the Constitution by taking the lead on the Bill of Rights, I think Chairman Bernanke may need to preserve the Federal Reserve through a similar strategy.
Jared Roy Endicott
Works Cited
Alesina, Alberto and Lawrence H. Summers. ”Central Bank Independence and Macroeconomic Performance: Some Comparative Evidence.” Journal of Money, Credit and Banking. Vol. 25 #2, May 1993. Web. 4 Aug. 2012.
Barnett, William A.. ”Audit the Federal Reserve?.” MPRA. University of Kansas. 26 Feb. 2010. Web. 2 Aug. 2012.
Barro, Robert J., and David B. Gordon. ”Rules, Discretion and Reputation in a Model of Monetary Policy.” Journal of Monetary Economics. North Holland: Elsevier Science Publishers B.V., 1983. Web. 2 Aug. 2012.
Crowe, Christopher, and Ellen E. Meade. ”Central Bank Independence and Transparency: Evolution and Effectiveness.” International Monetary Fund. IMF Working Paper, May 2008. Web. 2 Aug. 2012.
Dorning, Michael. ”Bernanke Favored by 71% in Investor Poll Preferring Fed Over ECB.” Bloomberg. 7 Dec. 2011. Web. 7 Aug. 2012.
Glyn, Noah. ”Beware ‘Audit the Fed’.” National Review. 31 Jul. 2012. Web. 3 Aug. 2012.
James, Joel. ”The Federal Reserve: Audited, Transparent and Independent.” Federal Reserve Bank of St. Louis. 2010. Web. 8 Aug. 2012.
Mishkin, Frederic S..The Economics of Money, Banking, and Financial Markets. Eighth Edition. Boston: Pearson Addison Wesley, 2007. Print.
Mishkin, Frederic S.. ”The Federal Reserve’s Enhanced Communication Strategy and the Science of Monetary Policy.” Federal Reserve. To the Undergraduate Economics Association, Massachusetts Institute of Technology, Cambridge, Massachusetts, 29 Nov. 2007. Web. 1 Aug. 2012.
Nasiripour, Shashien. ”Stiglitz, Nobel Prize-Winning Economist, Says Federal Reserve System ‘Corrupt’ .” Huffington Post. 3 May 2010. Web. 8 Aug. 2012.
Pangle, Thomas L.. “The Bill of Rights.” The Great Debate: Advocates and Opponents of the American Constitution. Chantilly, Virginia: The Great Courses, The Teaching Company, 2007. Video.
Paul, Ron. End the Fed. Grand Central Publishing, 2009. Print.
Pethokoukis, James. ”6 Economists on Why Ron Paul’s Fed Audit Idea is Wrong.” Reuters. 3 Aug. 2009. Web. 5 Aug. 2012.
Peterson, Kristina, and Siobhan Hughes. ”House Passes Ron Paul’s ‘Audit the Fed’ Bill.” Wall Street Journal. WSJ Blogs, Real Time Economics, 25 Jul. 2012. Web. 2 Aug. 2012.
Plato. Republic. The Internet Classics Archive. 380 B.C. Web. 7 Aug. 2012
Reid, Harry. ”I think we should audit the Federal Reserve.” Youtube, C-SPAN. Senate Floor, 25 Jan. 1995. Web. 2 Aug. 2012.
Salemi, Michael K.. “Central Bank Independence.” Money and Banking: What Everyone Should Know. Chantilly, Virginia: The Great Courses, The Teaching Company, 2012. Video.
Zumbrun, Joshua. ”Majority of Americans Say Fed Should Be Reined In or Abolished, Poll Shows.” Bloomberg. 9 Dec. 2010. Web. 7 Aug. 2012.
“Does the Federal Reserve ever get audited?.” Board of Governors of the Federal Reserve. Current FAQs, 2012. Web. 6 Aug. 2012.
“Transcripts and other historical materials.” Board of Governors of the Federal Reserve . Federal Reserve Open Market Committee, 2012. Web. 6 Aug. 2012.
“H.R.459 – Federal Reserve Transparency Act of 2012 (Engrossed in House [Passed House] - EH).” The Library of Congress. THOMAS. 25 Jul. 2012. Web. 7 Aug. 2012.
“H.R. 1094: Federal Reserve Board Abolition Act.” GovTrack.us. 15 Mar. 2011. Web. 7 Aug. 2012.
