Politicizing the Fed Is an Opening for Mischief

(Bloomberg View) -- It seems to be open season on the Federal Reserve. One congressional measure would audit the U.S. central bank. Another proposal is to overhaul the entire 100-year-old Federal Reserve System structure to update it to reflect changes to population and business centers. According to another view, the bank is operating without any theory or guidelines, so all of its policies are ad hoc and subject to the whims of its officials.

Certainly, there's no shortage of criticism or critics who say major changes are needed. Much of this reflects unspoken political agendas that would rein in the Fed's autonomy and ability to respond to changing and unprecedented economic conditions. It might be politically expedient for some, but it could result in a new central bank unable to address policy needs on a timely basis. Politicians should keep their hands off the Fed.

Most criticisms are cosmetic and deceptively hide a serious agenda: politicizing the Fed. The simplest argument is that the bank's 12 regional banks are no longer really representative of the country: The system was established more than 100 years ago, when the U.S.'s population west of the Mississippi was small, our commercial centers were predominantly in the east, and financial centers were almost exclusively in the northeast. If we were designing the Federal Reserve System today, its banks would be distributed very differently. 

But would such a change matter for policy? If the district banks were relocated, the presidents leading those institutions might also be different, but this might have no discernible effect on policy, which responds to economic conditions, not old politically drawn boundaries. But any effort to redraw these boundaries would actually be a stalking horse for more serious mischief.

Consider the push to “audit” the Fed. The central bank is already subject to audit, except for its monetary policies, which are the real issue for these critics. Under the guise of asking for a technical accounting, their aim is to establish political oversight over monetary policy through this audit review. To put the counterargument simply, should politicians who engage in highly partisan political battles -- and who can hardly agree on whether to raise the debt ceiling -- have the power to approve or disapprove Fed decisions on raising the cost of overnight money by 25 basis points? It would be hard to imagine a more disruptive change to the design of monetary policy.

Just look at the role of fiscal policy in economic management to appreciate how badly politicians could muck things up. President Barack Obama would not agree to a bill in favor of rebuilding our infrastructure, even though there's broad agreement that our nation's roads and bridges are falling apart, because he couldn't get Republican approval for other programs he wanted, even during the depths of the recession.

Fiscal policy changes need agreements across the political spectrum, which require deals in which each side gives something in exchange for what they really want. As a result, deals may fail even when both sides agree that there's a need to be met. Now, Trump is seeking some sort of infrastructure bill. But the economy is no longer in recession; labor is already scarce, so there aren't millions of unemployed people to put back to work; and any fiscal package would take a long time to gain approval, so it couldn't be implemented on a timely basis to serve as any kind of countercyclical policy. Those work well in textbooks, but the last time such a policy was actually put in effect was in the early days of the Kennedy administration, when a tax cut was approved to stimulate a weak economic expansion. For Congress to gain control over monetary policy would be highly likely to produce catastrophically untimely policy.

In this context, it is notable that Trump has commented that he likes low interest rates. This is perfectly understandable, given that he devoted much of his business career to the real estate market. But keeping interest rates at historically low levels when the unemployment rate is already at 4.5 percent and falling, even as inflation is slowly accelerating, is the antithesis of 1950s Fed Chairman William McChesney Martin's insightful comment that the Fed's job is to remove the punch bowl just as the party gets going.

It is safe to guess that any audit would quickly become inherently partisan. What would prevent a party holding a majority in Congress from implementing bad policy to weaken a president of the other party? Imagine if Congress audited Supreme Court decisions. Those would also become even more political. We appoint judges to the court for life to prevent them from being politicized. Similarly, Fed governors are appointed to long terms to enable them to make policy judgments free from such political influences. The Fed should remain shielded from political machinations.

Admittedly, members of Congress rely on their staffs to come up with good questions for Fed Chair Janet Yellen when she testifies. Without being able to tap their staffs, most members of Congress would have no clue what to ask or how to follow up in response to her answers. It is simply beyond their technical expertise. If Congress were to review and approve policy, it would have to be behind closed doors so we wouldn't be able to observe the lawmakers' incompetence on the issue and it would severely delay decision making.

The last criticism argues that the Fed is flying by the seat of its pants with regard to policy and its decision making is entirely ad hoc. Perhaps this is because economic conditions are unprecedented? The financial system almost suffered a total breakdown in 2008 after the Treasury, under Secretary Henry Paulson, chose to allow Lehman Brothers to fail and Congress was unable to pass the TARP bill to provide support for the banking system. Congress couldn't figure out or agree on how to shore up the financial system. Indeed, the bailout passed on the second try, after stocks melted down, but it was implemented in a completely different way than proposed and passed by Congress. (Paulson and then Fed Chairman Ben Bernanke actually learned from and followed the U.K., which bought preferred shares from their banks at very reasonable terms to safeguard its financial system.) There was no textbook model to follow. It is always much easier being a critic on the sidelines without the responsibility to formulate policy and implement it correctly. 

Rules can be set, but can they anticipate every possible economic environment? That's highly doubtful. We should continue to trust our well-intentioned appointees to the Fed and focus on choosing the most capable to serve, which will be the subject of my next article.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Charles Lieberman is chief investment officer and founding member at Advisors Capital Management LLC.

To contact the author of this story: Charles Lieberman at chuck@advisorscenter.com.

To contact the editor responsible for this story: Max Berley at mberley@bloomberg.net.

For more columns from Bloomberg View, visit http://www.bloomberg.com/view.