Briefing Paper No. 118

The Case for Auditing the Fed Is Obvious

Recently, the Federal Reserve has significantly altered the procedures and goals that it had followed for decades. It has more than doubled its balance sheet, paid interest to banks on reserves held as deposits with the Fed, made decisions about which institutions to prop up and which should be allowed to fail, invested in assets that expose taxpayers to large losses, and raised questions about how it will avoid inflation despite an unprecedented increase in the monetary base.

We should document why the Fed took each step, what the expected results were, and whether those results were achieved. What is surprising is not that many congressional colleagues support Rep. Ron Paul’s (R-TX) bill calling for an audit of the Fed. Remarkably, there is significant opposition to such oversight, and the political prospects for undertaking such an audit are relatively bleak.

This paper has three main sections. The first section looks at opposition to the audit. Although audit opponents express concern over keeping the monetary authority insulated from political pressure to inflate, one could argue that the larger threat to Fed independence comes from its departure from standard operating procedures. The second section looks at the processes on which an audit should focus. How did Fed officials undertake to determine whether this was primarily a liquidity crisis or primarily a solvency crisis? The third section looks at the outcomes on which an audit should focus. The profit or loss of the Fed’s investments would provide a very helpful indicator of whether the Fed’s actions served the economy as a whole or merely transferred wealth from ordinary taxpayers to bank shareholders.

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Arnold Kling is a Cato Institute adjunct scholar who writes about a wide variety of economic issues. Kling is the author of several books, most recently From Poverty to Prosperity and Unchecked and Unbalanced (both 2009).