Tag: Audit the Fed

Audit the Fed: What Would Milton Friedman Say?

Senator Rand Paul (R-KY) introduced a bill (S.264) which is popularly known as “Audit the Fed” (ATF). The bill picked up 30 initial co-sponsors. Although the Fed is already extensively audited in the accounting sense of the term, the ATF bill would expand the scope and scale of Fed auditing. Indeed, monetary policy decisions, which have been exempt from any sort of “auditing” since 1978, would see their auditing exemption lifted if the bill becomes law.

There is popular support for the idea that the Fed should be audited. More than three-quarters of registered voters would give the general idea of auditing the Fed a green light. It’s no surprise, then, that there has been bipartisan support for similar proposals in the past. However, none of these have become law because the push-back from Fed officials and other “experts” has been strong. Today is no different, with the Fed and the Obama White House all singing the same tune: “It’s Dangerous.” 

The real issue at stake is whether the Fed should be independent. The opponents of the ATF bill naturally think that the law would imperil the Fed’s autonomy and that this would be objectionable.

What would Milton Friedman say? Well, we don’t know for certain because unfortunately he is unable to read S.264. That said, Friedman weighed in on the issue of central bank independence on several occasions. Indeed, an essay he penned in 1962 was titled “Should there be an Independent Monetary Authority?” (In: In Search of a Monetary Constitution, edited by Leland B. Yeager, Harvard University Press). Friedman concluded that “The case against a fully independent central bank is strong indeed.”

Milton Friedman’s position on this issue was quite clear at the time. There is little doubt as to whether he would see the situation at hand any differently. 

Does Fed Leverage and Asset Maturity Matter?

Debate over whether to subject the Federal Reserve to a policy audit has occasionally focused on the size and composition of the Fed’s balance sheet. While I don’t see this issue as central to the merits of an audit, it has given rise to a considerable amount of smug posturing. Let’s step beyond the posturing and give these questions some of the attention they deserve.

First the facts. The Fed’s balance sheet has ballooned over the last few years to about $4.5 trillion. And yes, the Fed discloses such. No argument there. The Fed, like most central banks, has traditionally conducted its open-market operations in the “short end” of the market. The various rounds of quantitative easing have changed that. For instance the vast majority of its holdings of Fannie & Freddie mortgage-backed securities ($1.7 trillion) have an average maturity of well over 10 years. Similarly the Fed’s stock of treasuries have long maturities, about a fourth of those holdings in excess of 10 years.

Now the leverage question. We all get that the Fed cannot go “bankrupt” like Lehman. But that’s because “bankrupt” is a legal condition and one from which the Fed has been exempted. Just like Fannie and Freddie cannot go “bankrupt” (they are considered legally outside the bankruptcy code). The eminent economist historian Barry Eichengreen tells us the Fed’s leverage doesn’t matter as “the central bank can simply ask the government to replenish its capital, much like when a government covers the losses of its national post office.” Some of us would say that’s a problem not a solution, just like it is with the Post Office.

Others would suggest the Fed’s leverage doesn’t matter because “the Fed creates money”. Again that misses the point. Any losses could be covered by printing money, but isn’t that inflationary?  And that, of course, is just another form of taxation. So it seems Senator Paul’s primary point, that the Fed’s balance sheet exposes the taxpayer to some risk has actually been supported, not discredited, by these supposed rebuttals.

Let’s get to another issue, the maturity of the Fed’s assets. There’s a good reason central banks generally stay in the short end of the market. It avoids taking on any interest rate risk.  When rates go up, bond values fall. Yes the Fed can avoid recognizing those losses by simply not selling those assets. But that creates problems of its own. If we do see inflation, normally the Fed would sell assets to drain liquidity from the market. But would the Fed be willing to sell assets at a loss? At the very least there would be some reluctance. And yes they could cover those losses by printing money, but that’s hardly helpful if the Fed finds itself in a situation of rising prices.

The point here is that the Fed’s balance sheet does raise tough questions about its exit strategy.  Perhaps the economy will remain soft for years and the Fed can exit gracefully.  Perhaps not.  I raised this possibility before Congress a year ago.  I don’t know anyone with a crystal ball on these issues.  But one thing is certain, this is a debate we should be having.  Its the “nothing to see here, move along” crowd that poses the true risk to our economy.

Fact Checking the Fed on “Audit the Fed”

With the introduction of bills in both the House (H.R. 24) and Senate (S.264) allowing for a GAO audit of the Federal Reserve’s monetary policy, officials at both the Board and regional Fed banks have launched an attack on these efforts.  While we should all welcome this debate, it should be one based on facts.  Unfortunately some Fed officials have made a number of statements that could at best be called misleading. 

For instance Fed Governor Jerome Powell recently claimed “Audit the Fed also risks inserting the Congress directly into monetary policy decisionmaking”.  I’ve read and re-read every word of these bills and have yet to find such.  H.R. 24/S.264 provide for no role at all for Congress to insert itself into monetary policy, other than Congress’ existing powers.  I would urge Governor Powell to point us to which particular part of the bill he is referring to, as I cannot find it.

Not Too Late to “Audit the Fed”

Last week I wrote about Senator Sanders’ “compromise” with Senator Dodd and the White House on auditing the Federal Reserve.  To re-cap, the compromise would drop any auditing of monetary policy and simply focus on the Fed’s emergency lending facilities.  See my previous post for why I believe that compromise is a big win for the Fed and a loss for the American public.

The good news is that Senator Sanders’ compromise does not end the debate.  Senator Vitter has filed an amendment (#3760) that mirrors the original Sanders’ amendment, including an audit of monetary policy.  With any luck, other Senators will be able to decide for themselves whether the Sanders-Dodd compromise offers sufficient transparency of the Fed’s actions.

I also highly suggest reading Arnold Kling’s recent Cato briefing paper on the issue, “The Case for Auditing the Fed Is Obvious.”

Tuesday Links

  • Surprise! The “financial reform” bill is full of kickbacks to well connected cronies: “The public needs to understand that, far from protecting the little guy and sticking it to the fat cats, this bill keeps good, old-fashioned political patronage alive and well.”
  • When did this happen? “Historians find long-lost clause of U.S. Constitution giving federal authorities unlimited jurisdiction over the American palate.” Oh wait, it didn’t.

No, the Fed Did Not Stabilize the Economy

Commenting on a recent article of mine in The Wall Street Journal, Peter Gartside claims that:

Prior to 1913, the U.S. annual gross domestic product changes oscillated between extremes of approximately plus or minus 15%.   After the establishment of the Federal Reserve Board, the limits of GDP oscillations narrowed to approximately plus or minus 6%.

You may well wonder where he got that idea, since there are no official estimates of gross domestic product (GDP) for years before 1929.  In the early 1960s, however, John Kendrick and Simon Kuznets bravely attempted to construct such estimates for gross national product (GNP).  That would be close enough to modern GDP data were it not for the primitive statistics and technology they had to work with.

The table (after the jump) shows these heroic old estimates for real GNP from 1889 to 1914.  In that period, there was only one year (1908) in which the drop in GNP exceeded 6% and none that remotely approaches the  “minus 15%” figure of Mr. Garstide’s imagination.

Real GNP
billions of 1958$

1889    49.1
1890    52.7
1891    55.1
1892    60.4
1893    57.5
1894    55.9
1895    62.6
1896    61.3
1897    67.1
1898    68.6
1899    74.8
1900    76.9
1901    85.7
1902    86.5
1903    90.8
1904    89.7
1905    96.3
1906    107.5
1907    109.2
1908    100.2
1909    116.8
1910    120.1
1911    123.2
1912    130.2
1913    131.4
1914    125.6

Historical Statistics of the U.S., Series F4

CEA chair Christina Romer’s research shows that these early estimates “exaggerate the size of cycles because they are based on the assumption that GNP moves approximately one for one with commodity output valued in producer prices.” If we tried to estimate recent GDP figures on the basis of commodity output and prices, then postwar cycles would look even wilder than they already do.  Consider, for example, using the recent gyrations in producer prices of oil and metals as a proxy for GNP.

Even if we relied on the ancient and flawed pre-Romer GNP estimates above, however, there were still no downturns before 1913 that were nearly as extreme as 1929-33 or even 1920-21.  And there was no recession between the 1870s and 1913 that lasted as long as the slump of 2008-2009.

Whether we’re talking about fiscal or monetary fine-tuning, all the technocrats efforts at taming the business cycle in the past 40 years appear no more successful than the pre-Fed policies of doing without a central bank and doing without deferred tax increases (debt-financed “fiscal stimulus” plans).

Support for Federal Reserve Audit Increasing

Last week Cato hosted a policy forum on “Bringing Transparency to the Federal Reserve,” featuring Congressman Ron Paul. As mentioned in CQ Politics, Rep. Paul’s bill, HR 1207, has been gaining considerable momentum in the House, with currently 244 co-sponsors, ranging from John Boehner to John Conyers Jr. In fact, the Senate companion bill was introduced by Senator Bernie Sanders.

Fed Chairman Ben Bernanke discussed the very topic of Federal Reserve Transparency at Cato’s annual monetary conference in the Fall of 2007.

After praising moves toward greater transparency at the Fed, Bernanke argued that “monetary policy makers are public servants whose decisions affect the life of every citizen; consequently, in a democratic society, they have a responsibility to give the people and their elected representatives a full and compelling rationale for the decisions they make.”

Chairman Bernanke also goes on to argue that “improving the public’s understanding of the central bank’s objectives and policy strategies reduces economic and financial uncertainty and thereby allows businesses and households to make more-informed decisions.” Bernanke’s full remarks can be found in the Spring 2008 issue of the Cato Journal.

Over the last two years, we have seen an almost tripling of the Federal Reserve’s balance sheet to $2.3 trillion, resulting from the bailouts of AIG and Bear Stearns and the creation of 14 new lending programs.

Our recent forum, and Rep. Paul’s bill, bring much needed debate and focus to the issue of Fed’s inner-workings.