A More Accountable Fed

Much of what ails this economy was caused by the Federal Reserve. Not all that damages the economy can be laid at the Federal Reserve’s door, but much can be. I have written about the Federal Reserve’s culpability in a number of posts now, and many who have had the stamina to read through them all may think I am beginning to beat a dead horse. For those of my readers here who have not gone through this exercise, I recommend reading the posts listed on the thematic post page for the Federal Reserve System to understand exactly why the Federal Reserve is guilty of helping to create many of our economic problems. The subject of today’s post, however, is not the fact of the Federal Reserve’s culpability, but  rather the fact that so many other people are now realizing how much the Fed is at the root of many of our problems.  

Over the last two weeks I have watched a number of TV economic commentary shows in which the Fed was bashed for the dog’s mess that is our stock markets. Many are beginning to realize the Fed has decoupled the stock markets from how well the economy is performing and how well companies are earning. Instead what investors care about is how expansive the Fed’s monetary policy is. How much of a dog’s mess are the stock markets? See the charts as of September 9, 2015 below.

There is a very real possibility the markets might transition from a correction to a bear market, exactly the opposite of what the Fed has been trying to achieve.

In this RealClearMarkets article, Alex Pollock points out how remarkable it is that such a small number of economists on the Federal Open Market Committee (FOMC) can have such incredible power with almost no accountability to the rest of the nation. The Chairman of the Federal Reserve does have to testify to the U.S. House Committee on Financial Services semiannually about the Board of Governors’ semiannual report. That is it. Other than the report and the Chairman’s testimony on what it means, there is no other accountability. Neither the Board of Governors nor the FOMC has any need to get approval for their decisions from any other branch of government. This is why I often like to refer to the Fed as the fourth branch of government.

Thus, the entire nation is completely dependent on the twelve members of the FOMC – all seven Governors on the Board of Governors, the President of the Federal Reserve Bank of New York, plus four rotating voting members from the remaining regional federal reserve banks – for the monetary policy that is best for the American economy’s health. These 12 economists base their guesses on the correct monetary policy on debatable economic ideas (based on Keynesianism in recent decades), which have led to the inflation of asset bubbles producing national financial catastrophes, occasionally producing high inflation, and helping the federal government to finance irresponsible budget deficits. This is a great deal of national economic pain to be caused by such a small number of people with close to no accountability.

Make no mistake, however. There was a very good reason to put monetary policy into so few hands! The people who legislated the Fed into being in 1913 must have been a lot more worried about putting all that economic power in the hands of career politicians in either the legislative or executive branches. Even back then they must have had some appreciation of the fact that politicians more often than not make economic decisions for noneconomic reasons. If this power were put in the hands of the politicians, they would almost constantly choose an easy money policy that would put us in an environment of chronic high inflation.

Nevertheless, given the very poor history of the Federal Reserve since at least 1928, when the Fed started an ill-advised “real bills” monetary policy that was the real cause of the Great Depression, the economists controlling the Fed have given us very little reason to have confidence in them. More recent malfeasance by the Fed is summarized in Current Economic Effects of the Federal Reserve. The good news, the one silver lining in the steeply falling stock market mess of the last two weeks, is the fact that an increasing number of people are realizing that something must be done to limit the damage the economists in the Fed can do.

One response to this realization is Senator Richard Shelby’s Financial Regulatory Improvement bill. It is a rather large bill and a work in process as amendments are offered and voted upon. The bill is complicated by the fact that that the Dodd-Frank Act has given the Fed regulatory oversight of the financial industry, including insurance, securities, commodities, and bonds. The bill proposes that the Congress closely supervise the Fed in these regulatory activities. Nevertheless, a perusal of a section-by-section summary of the bill , a discussion draft, yields the following provisions in Title V as among the most important.

• Section 501 changes the Fed’s reporting requirements by requiring a quarterly report of the Financial Stability Oversight Council (FSOC) in place of the semiannual Federal Reserve report, with a quarterly report by the Federal Open Market Committee (FOMC). The FSOC was established by the Dodd-Frank Act to regulate the financial industry and is organizationally under the Treasury Department.  The council is chaired by the Secretary of the Treasury and includes the Chairman of the Federal Reserve. The Fed’s new regulatory duties are derived through the FSOC. The Fed Chairman still testifies semiannually. Most importantly, the section does not require the FOMC to follow any monetary rule or rules to prescribe monetary policy, but it does require the FOMC to denote in the report what monetary rules the FOMC has used or considered.
• Section 504 transfers the authority for setting interest rates of commercial banks’ excess reserves at the Fed from the Federal Reserve Board of Governors to  the FOMC.
• Section 505 creates an independent commission to study a possible restructuring of Fed districts to include possibly increasing or decreasing the number of districts.
• Section 506 requires the Government Accountability Office (GAO) to study the the regulation of “systemically important financial institutions” by the Federal Reserve Banks “in order to best address systemic risk and prevent regulatory capture.”
• Section 507 requires the Fed to study its plan to regulate and supervise nonbank institutions and make a report to Congress on it every two years for ten years.

Most of the rest of the bill is devoted to FSOC regulation under the Dodd-Frank act and its amendment. Disappointingly, the sections cited above do not require the Fed to adopt  a specific monetary rule or a monetary rule of their choice and to report on it, but only to report on any rule they do adopt or consider. The bulk of the Title V provisions seem to merely require more reporting with greater frequency. Perhaps, this is the way things must be done in politics, to set the stage for more thorough reforms with initial smaller steps. Let us hope we will not have to wait for long.

The status of Shelby’s bill in the senate is that it has been attached to an appropriations markup and passed out of the Senate appropriations committee. This would give the bill immunity from filibuster.

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