— Retransmitting Story Sent 12:42 ET to Add USA in the Headline
By Steven K. Beckner
(MNI) – Having apparently dodged perhaps the biggest threat to its
political independence in its history, the Federal Reserve can breathe a
sigh of relief — and so can the American people.
The financial regulatory reform bill approved early Friday by a
House-Senate conference committee does not contain the provisions most
feared by the Fed and others concerned about keeping the nation’s
monetary policy free of political influences.
As it turns out, the Fed will not be subjected to audits of future
monetary policy decisions by the Government Accountability Office, a
Congressional watchdog agency, although the GAO has been given expanded
authority to look at the Fed’s emergency lending and assets purchases
during the financial crisis.
The bill also would require the Fed to identify firms that borrow
from the Fed’s discount window or that participate in other Fed programs
after a two-year lag.
And the compromise reached between House and Senate conferees would
allow the GAO to conduct ongoing audits of the Fed, including the Fed’s
discount window and open market transactions. It would require public
disclosure of open market operations and discount window transactions
three years after the transactions have occurred.
But that is far less onerous and threatening than the measure
originally proposed by Rep. Ron Paul, R-Tex., and others that would have
allowed the GAO and Congress to second guess every politically sensitive
interest rate decision the Fed makes.
Significantly too, the bill does not provide for Presidential
appointment and Senate confirmation of Federal Reserve Bank Presidents
generally or the New York Fed President in particular.
Proposals to turn the regional Fed presidents into political
appointees had alarmed the Fed — particularly the Federal Reserve Bank
Presidents themselves.
“Were regional Reserve Bank presidents to become political
appointees, they would be more attuned to the political process in
Washington that selected them, rather than having a public interest in
the broad economic health of the nation and the Reserve Districts in
which they reside,” warned Philadelphia Fed President Charles Plosser.
“Any shift in power in Washington and New York at the expense of
the other Reserve Banks would undermine the delicate balance of our
uniquely decentralized central bank and lead to a central bank that is
more interested in politics and Wall Street than in the economic health
of Main Street,” he said.
There are, however, new restrictions on the role commercial bank
members of Federal Reserve Banks’ boards of directors can play in
selecting the Banks’ presidents.
Another key victory for the Fed is that it kept its cherished
authority to supervise thousands of smaller banks, as well as the
largest, most systemically important financial institutions.
St. Louis Fed President James Bullard, among others, objected to
limiting the Fed’s role to regulating the largest firms, making it a
“Wall Street only Fed.”
“The Fed should remain involved with community bank regulation so
that it has a view of the entire financial landscape,” he said. “It is
important that the Fed does not become biased toward the very large,
mostly New York-based institutions.”
Regulating a broad range of banks, large and small, “helps the Fed
make sound monetary policy decisions,” he said in April.
Fed officials had argued strenuously against what it perceived as
threats to its independence — and with justification.
The Fed is coming into a particularly sensitive time in which it
will have to make tough choices about raising interest rates from near
zero and otherwise tightening monetary policy. And it will be doing so
at a time of record budget deficits.
There could be political pressure to keep rates low not only to
support the recovery but also to hold down the cost of financing those
deficits.
The mere existence of some of the proposed shackles might have
called into doubt the Fed’s independence, damaged its credibility in
financial markets and led to a deterioration of inflation expectations.
Had some of the offending provisions not been removed from the
final bill, the market would have never known whether a given Fed
decision to delay rate hikes was motivated by sound economic
fundamentals or a desire to avoid the wrath of Congress.
As Plosser pointed out in the Philadelphia Fed’s recently released
Annual Report, independence “will be even more important for the Fed
going forward.”
“During the recent crisis, the Fed took extraordinary measures,” he
wrote. “At some point, however, the Fed must unwind this support,
increase short-term interest rates, and drain some of the money it has
pumped into the economy during the recession.”
He declared that “the Fed must have the independence to take these
actions without short-term political interference if it is to achieve
Congress’s dual mandate.”
Other central banks have fallen prey to political influence or been
entirely captured by the politicians with very painful consequences. The
history of Latin America is replete with instances of central banks
financing governments via the printing press, resulting in
hyperinflation. And, of course, there have been notorious examples in
the industrialized world, most infamously the Weimar Republic in
Germany.
For that matter, the Fed itself, arguably, bent to political
pressure in the 1970s, contributing to the double digit inflation which
required painful measures to cure.
With the federal deficit headed toward a record $1.6 trillion, the
Fed will need all of its independence and gumption to stay focused on
price stability rather than accommodating both economic growth and the
borrowing needs of the Treasury Department.
** Market News International **
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