Fed should be left alone on money decisions

It appears likely that Congress will punish the Federal Reserve for its role in the financial crisis by taking away some of its independence and responsibilities. The legislators are scapegoating.
DEC 16, 2009
By  MFXFeeder
It appears likely that Congress will punish the Federal Reserve for its role in the financial crisis by taking away some of its independence and responsibilities. The legislators are scapegoating. In the House of Representatives, more than 300 members joined Rep. Ron Paul, R-Texas, as co-sponsors of legislation to audit the Fed's decisions on interest rates and lending to member banks. Even Fed critic Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee, thinks that that is a bad idea. Sharing his view are former Fed Chairmen Alan Greenspan and Paul Volcker; Alice Rivlin, founding director of the Congressional Budget Office; and many other economists. In another attack, both the House Financial Services Committee and the Senate Banking Committee are considering altering the makeup of the Fed's monetary-policy arm, which currently is dominated by private bankers. Either move would put the Fed under greater political pressure when making decisions about interest rates and the money supply. As argued in a previous editorial, removing some of the Fed's responsibilities so it can concentrate better on its most important ones — managing the nation's money supply to help stabilize the economy and regulating the nation's major banks — is a viable idea. But reducing the Fed's independence from political interference is a poor idea, especially when done mainly to appease an angry public and divert attention from Congress' role in the crisis and its own dismal standing with the electorate. Virtually all wealthy nations insulate their central banks because they realize that economic growth is most likely to come when monetary policy is determined without political interference. Reducing Fed independence would be a grave mistake for Congress, one the country would no doubt rue in the years ahead. To be sure, the Fed is not perfect. Many claim that its easy-money policy in the late 1990s led to the technology bubble. When the Fed followed such a policy again between 2002 and 2007, the result was the housing bubble. But critics forget that the Fed's easy-money policy before the tech bubble was an attempt to prevent a worldwide recession in the wake of the Asian financial crisis. They also forget that in 2006 and 2007, the Fed tried to tighten the money supply, pushing three-month Treasury bill rates up to more than 5% early in 2007 and six-month T-bills to close to 5.1% by mid-July of that year. The Fed was thwarted in these moves by insatiable foreign demand for long-maturity Treasuries — particularly from China. That demand kept long-term rates low. The worst that can be said of the Fed in the housing bubble is that it and other regulators failed to recognize the deterioration in mortgages and mortgage-backed securities. On the other hand, the Fed's actions in the depths of last year's crisis helped stave off a depression. By all means, Congress should oversee the Fed's action by asking for explanations at hearings after a crisis has passed. Unfortunately, the current proposals are likely to lead to political pressure on the Fed in both routine and crisis situations.

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