Rand Paul’s popular “Audit The Fed” legislation, recently reintroduced with 30 Senate co-sponsors, has received mounting criticism over the past few days, not only from the White House, but also from some of the Fed’s most hawkish members and outspoken Fed critic Senator Elizabeth Warren (D., Mass.).
As a former Fed employee who is familiar with the generally mundane inner workings of monetary policy, I am shocked that the Rand Paul effort has grown in popularity. It unfairly assails the country’s central bank for political gain at the potential cost of monetary-policy independence.
First, an “audit” of the Fed of the sort that Rand Paul’s bill proposes is redundant and would hinder the Fed’s ability to communicate its stance on monetary policy.
The Fed in fact already has several audits in place, which are convened by the Government Accountability Office and the Fed’s inspector general to ensure that institutional money in the Fed’s liquidity programs and other operations is accounted for.
The purpose of a traditional financial audit is to identify accounting irregularities, with the goal of thwarting fraud, embezzlement, and money laundering. Unlike commercial banks, which have scores of individual clients whose accounts require thorough audits, central banks such as the Federal Reserve house a limited number of interest-paying accounts, for institutions that use the Fed’s liquidity programs. The political purpose of the Paul “Audit the Fed” bill is, rather, to audit the monetary-policy statements issued by the Fed, in the hope of gaining not just more transparency in Federal Reserve policymaking, but also more influence for Congress when it comes to monetary-policy decisions. However well-intentioned the desire for government transparency, this proposal is ultimately a dangerous threat to central-bank independence, which is crucial to the effectiveness of monetary policy.
Financial markets and economic forecasters scrutinize every word in statements by individual Federal Reserve officials and the joint Federal Open Market Committee (FOMC). There have been tense internal debates between Fed officials over the use of specific words and phrases — for example, whether the Fed should be described as “patient,” and whether there will be a “considerable time” before interest-rate hikes will commence.
Fed statements such as these are powerful. They set interest-rate expectations and ultimately reduce the cost of borrowing, which in turn has helped the U.S. economy recover from past economic collapses.
New “audits” forcing the Fed to disclose private e-mails and other correspondence between Fed officials could add unnecessary volatility to financial markets. If the past few years have taught us anything about financial markets, it is that central-bank statements can cause immediate shocks (both positive and negative) to financial markets.
Critics of quantitative easing demand to know, “Who is the Fed buying long-term assets from?” But the Fed has already told us the answer: It buys bonds from the 22 primary dealers who are publicly listed. Any further information on exact timing and quantities of bonds purchased from individual banks could create opportunities for traders to “front-run” the Fed’s traders and the banks who have sold securities to the Fed. This is the same reason private banks do not disclose their trading records beyond their profit-and-loss statement.
Second, the Federal Reserve has already made several steps in recent years toward promoting transparency into its monetary-policy decisions.
Since 2008, the Fed has published federal-funds-rate forecasts known as “forward guidance,” which indicate the Fed’s stance on future monetary policy (this forward guidance is contingent on the economy’s meeting certain targets on unemployment, GDP, and inflation). In 2011, Ben Bernanke held the first Fed press conference in history, creating a new forum for the Fed chair to take questions from all types of financial journalists.
In 2012, the Fed announced that it was adopting the “Evans Rule,” which stated that the Fed would not begin raising interest rates until either unemployment fell below 6.5 percent or inflation went above 2.5 percent. And in 2014, the Federal Reserve Board of Governors made its standard model of the economy available to the public.
Certainly, more could be done to further Fed transparency. While the Fed is unlikely to go as far as to bind itself to a mathematical monetary-policy rule such as the one advocated by Stanford economist John Taylor, it could do an earlier release of some of its FOMC monetary-policy memos (such as the “Bluebook” containing a number of monetary-policy rules and “policy alternatives”), which currently is published with a five-year lag.
Third, requiring the Fed to make a substantial amount of public disclosures and deliver congressional testimony explaining monetary-policy decisions could create outsized political influence on the Fed, whoever happens to be in charge of Congress.
At one extreme, overt Democratic influence on the Fed could lead to a monetization of the debt, “helicopter money” as a fiscal stimulus, or a generally more accommodative monetary policy (which results in “higher inflation and bad economic outcomes,” according to former Fed governor Jeremy Stein). At the other extreme, overt Republican influence on the Fed might lead the country back to a gold standard, which can hinder economic growth by diminishing the money supply (as evidenced by Ben Bernanke’s research on the Great Depression).
In recent years, the Fed has arguably already become more politicized. In 2013, a grassroots Democratic effort lobbied against former Harvard president Larry Summers’s candidacy for the Fed chairmanship, ultimately prompting him to withdraw interest, making way for Janet Yellen, an arguably more dovish candidate.
Rather than try to create a politicized “audit” of the Fed, Congress should spend more time working toward trade deals such as the Trans-Pacific Partnership and serious tax reform, including a reduction in the abnormally high U.S. corporate-tax rate. Congress’s time could be much better spent on pro-growth strategies than on counterproductive investigations of the Fed.
— Jon Hartley is an economics contributor for Forbes and the co-founder of Real Time Macroeconomics LLC, a financial-technology firm. You can follow him on Twitter at @Jon_Hartley_