A New Fed-Treasury Accord

Charles Plosser, President of the Federal Reserve Bank of Philadelphia, gave an important speech last week.  He mounted a strong defense of what is known as Fed independence. “Central bank independence means the central bank can make monetary policy decisions without fear of direct political interference.”

Toward the end of the speech, Plosser admitted the Fed had brought criticism down on itself by blurring the line between monetary and fiscal policy.  In the process, the central bank greatly expanded its balance sheet and substituted “less liquid, long-term assets, such as securities backed by mortgages guaranteed by Fannie Mae and Freddie Mac, for the short-term securities it typically held before the crisis.”

To extricate itself from conducting fiscal policy and get back to doing conventional monetary policy, Plosser called for a new Fed-Treasury Accord.  (He harkened back to the Accord of 1951, which ended the Fed’s wartime obligation to support the prices of Treasury bonds.)  Under the proposal, the Fed would swap out its illiquid assets for Treasury obligations.  Responsibility for public support of housing would revert to Treasury and be subject to Congressional appropriations.

Additionally, and very importantly, Plosser recommended ending or severely curtailing the Fed’s expanded lending authority, which enabled it to balloon its balance sheet and conduct fiscal policy. (That is the section 13(3) authority.) “Never again” is the message of Plosser’s speech.

It was a landmark speech by a high Fed official.