Don’t Audit the Fed, Restructure It
An active -- and often colorful -- debate surrounds recent legislative proposals to “audit” the Federal Reserve. While participants on both sides of this debate have not always been careful to explain exactly what such an “audit” would entail, all of these proposals emphasize that the central bank requires closer monitoring. Some even hint that the Fed is engaged in nefarious activities which, if brought to light, would meet with objections from the American public. Here, we take calls for reform seriously, and propose some structural changes that would turn the Fed into a more transparent, accountable, and ultimately more effective institution.
Richard Fisher, President of the Federal Reserve Bank of Dallas, recently responded to discussions of reform by suggesting that some powers be shifted away from the Federal Reserve Bank of New York and that the position of Vice-Chair of the Federal Open Market Committee (FOMC) should be filled, on a rotating basis, by presidents of all the regional banks. Fisher’s remarks highlight very serious concerns that many observers have over the possible “regulatory capture” of the Fed by large and powerful banking institutions.
Indeed, a broader restructuring would address this issue head-on. A first step would be to reduce the number of Federal Reserve districts from twelve to five and make the presidents of those five Reserve Banks permanent voting members of the FOMC. These institutional changes would strengthen the hands of all the bank presidents combined and would correspondingly dilute the unique power and influence associated with the New York Bank in particular. Furthermore, this change would only continue the gradual consolidation that has already occurred on Fed’s operational side, as innovations in computing and transportation have led to the elimination of traditional duties of many regional branches and concentrated functions in specific offices at specific locations.
Concentrating the System’s activities at fewer offices would not compromise the Fed’s primary responsibilities. If the remaining offices were located in New York, Atlanta, Chicago, Dallas, and San Francisco, the regional diversity emphasized when the Fed was founded would still be preserved. To the contrary, as noted above, a smaller number of Reserve Banks, with presidents serving as permanent voting members of the FOMC and supported by active research staffs, would gain an even stronger role in shaping monetary policy decisions.
A smaller number of Reserve districts also would enhance the Fed’s responsibilities for supervision and regulation of commercial banks. In line with suggestions that trace to former Chairman Paul Volcker, it is possible to argue that the Fed can support the safety and soundness of the payments system by directing its efforts towards examinations of only the very largest bank holding companies, which now hold a very high percentage of all banking assets. Most of these institutions are located in or near the five cities that would continue to serve as centers for the smaller number of Fed districts. This change would focus the Fed’s supervisory efforts on institutions that pose the threat of systemic risk and transfer the oversight of smaller banking firms to other regulatory agencies.
Many who resist initiatives to “audit” the Fed are concerned that such legislation would give Congress influence, if not control, over the conduct of monetary policy. Such concerns, however, confuse the idea of “independence” with that of “accountability.” Congress always has retained the power to establish the Fed’s policy goals; its 1977 amendment to the Federal Reserve Act, for example, represents the source of the “dual mandate,” identifying “stable prices” and “maximum employment” as the two main objectives for monetary policy. “Independence” means only that the Fed is free to choose how these goals are pursued, so that short-run political pressures do not compromise its ability to achieve longer-run objectives. Missing from this delegation of duties, however, is any notion of “accountability” if the Fed fails to achieve the goals that Congress has established. Nothing has been said, for example, as to what will happen if the Fed allows inflation to persistently rise above or fall below its previously announced two-percent inflation target. Answering such questions should be a point of focus for any effort to reform the Fed.
The conduct of monetary policy also could be improved with other changes. For all the talk about “transparency,” for example, the process -- or rule -- by which the FOMC intends to defend its two-percent inflation target remains unknown. In the meantime, the frequent and often conflicting views of monetary policy expressed by 19 independent FOMC members often seem to introduce greater uncertainty about how monetary policy will evolve. Once again, a smaller, but potentially more powerful, group of Reserve Bank presidents would ensure that all views are brought to the table, while also making policy debates and decisions easier for the public to understand.
Michael Belongia is a professor of economics at the University of Mississippi. Peter Ireland is a professor of economics at Boston College and a member of the Shadow Open Market Committee.
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