If there is one constant in the world of governance, it is that those individuals and institutions with power will fight tooth and nail to keep their power concentrated in the hands of the few. It’s human nature to pursue self-interest, to prevent others from chipping away at our decision-making abilities. Yet as we know from experience, it is this exact situation which gives rise to tyranny–when a small minority makes exclusive decisions which impact the lives of a much greater majority.
And yet, this is exactly how the Federal Reserve, or the “Fed,” operates in constructing monetary policy, which directly impacts each and every American. Do you know the interest rate that you’re paying on your loans, or the interest on you are receiveing on your savings in the bank? Do you know how easy it is to get a new credit card or take out a new loan from the bank? Have you compared the value of the U.S. Dollar against other currencies? These factors are directly influenced by the decisions of twelve individuals within the Fed. Yes, twelve.
First, a bit of background on the structure of the Fed. Though the Fed has many responsibilities including regulation and economic research, it is their monetary policy which has the most widespread impact on all Americans. A subset of the Fed, called the Federal Open Markets Committee (FOMC), meets eight times per year to craft monetary policy decisions. The FOMC is comprised of the 7 members of the Federal Reserve Board of Governors, along with the heads of 5 of the 12 regional Federal Reserve Banks. Collectively, these individuals determine benchmark interest rate levels given the condition of the U.S. economy, and they decide what open-market operations are necessary to reach their benchmark. The Board of Governors and the heads of the regional Federal Reserve Banks are each appointed by the President and confirmed by the Senate for fixed terms.
So, let me get this straight. A combination of twelve unelected individuals collude together to determine the interest I have to pay back on my debt? To determine the purchasing power of my money in other countries? In short, yes. But that’s not the least undemocratic element of the Fed.
Like many central banks, the Federal Reserve was designed to be somewhat politically insulated, but has since accumulated more political independence over time. In fact, it is no longer accountable to any aspect of the government. It may technically be a branch of the Department of Treasury, but short of nominating individuals for Fed positions, the President has zero control over the Fed and its actions. The Government Accountability office is barred from auditing any of the Fed’s monetary policy decisions. Even Congress can only influence the Fed by approving individual members and ascribing the body namely regulatory responsibilities.
In fact, the Fed is “independent,” and is “not an agency” of the Federal Government. Thus, the Fed is even immune to the Freedom of Information Act, which is instrumental in allowing the media to hold our government accountable. Moreover, in her testimony this week, Janet Yellen strenuously argued against the “Audit the Fed” measure currently gaining traction in both Houses of Congress, for fear that it will supposedly limit the Fed’s political independence.
So basically, all we can do is sit back and trust that the twelve members of the FOMC will make benevolent decisions which positively impact everyone. That might work well in an economic utopia, but not in the world’s largest and most diverse economy. Especially given the specific context of crafting monetary policy, allowing the FOMC to have free reign is dangerous for all of the following reasons.
For one, the process of crafting monetary policy is much more theoretical than the practices of most other government agencies. While most policies are targeted to directly achieve their ends, the FOMC operates through cause and effect relationships; that is, they conduct open market operations (buy and sell short-term government securities) and set interest rates on the discount window with the hopes of influencing interest rates to land at their intended level. Of course, this process is hardly an exact science, which you would think necessitates the involvement of more individuals than just those on the FOMC to make sure that all variables are accounted for.
Even more critical is the exact interest rate which the FOMC elects to use as their benchmark rate. One of the primary goals of the Fed is to use interest-rate targeting to help the country maintain its long-run equilibrium level of output. However, the Fed has two problems: it cannot be sure that its policy will produce the interest rates it is targeting, and it cannot ensure that its interest rate target will produce the larger macroeconomic effects that it is hoping to achieve in a given situation. Of course, how the Fed weights these factors, as well as its goals, remains firmly closed to the public as monetary policy construction is shrouded in secrecy. In fact, these two factors serve as constant sources of debate in the economics community, often without a clear consensus as to how to proceed.
The problem is that the price of a mistake by the Fed can be disastrous for the country. For example, economists criticized former Fed Chair Alan Greenspan for lowering interest rates too far in the wake of the 2001 recession. As Greenspan and the Fed ignored its critics at the time, most economists now conclude that the Fed contributed to the housing bubble of the mid 2000s by holding interest rates too low for too long.
This issue cuts to the heart of the problem: the Fed “does what it wants” regardless of what others outside the organization think. And when the Fed is wrong, it’s we, the American people, who pay the price.
Today, the stakes surrounding the Fed are even higher because of the unprecedented actions they took in response to the financial crisis of 2008. For one, the Fed attempted to stimulate the economy by purchasing trillions of dollars of long-term securities through a program known as quantitative easing. Moreover, the Fed has held their benchmark interest rate at 0-0.25% for approximately 7 years now, a policy which has never been tested in any modern economy. In theory, these policies should help stimulate the economy by lowering interest rates to spur lending and personal expenditures. But these are purely theories! No one inside or outside the Fed has any idea whether these goals will actually come to fruition. So I suppose we are all guinea pigs now in the Fed’s giant economic experiment–though it seems more like a highly levered bet to me.
And what are the costs if the Fed is wrong? Potentially devastating. For one, the possibility of inflation hangs on the horizon by virtue of all the money the Fed has pumped into the economy. Moreover, the Fed stimulus has caused financial markets to swell to bubble levels since early 2009, far outpacing the lackluster economic recovery. There is a very real possibility that the next recession that occurs will be much worse since the Fed has inflated financial markets. Add this to the very real fact that numerous economists, including renowned monetary policy expert John Taylor, doubt the effectiveness of Fed policies. In fact, some even wonder whether the Fed has lost its ability to control monetary policy by virtue of such unprecedented actions.
These occurrences would be an unmitigated disaster, paid for not by Janet Yellen or anyone with the Fed, but by us, the American people.
This is not how a democracy is supposed to operate. Our Founding Fathers spent endless months deliberating about how to prevent a government from functioning in this way. Yet the Fed functions as the sole judge, jury, and executioner of monetary policy. Where are the separations of power? Where are the checks on the Fed’s authority? Where are our democratic values of multi-faceted decisions and public participation by the citizenry in crafting monetary policy? Where is the transparency in the formation of monetary policy?
That is why I propose not to just audit the Fed, but to ultimately limit its political independence. For one, I recommend that both the House Financial Services Committee and the Senate Banking Committee have veto power over any of the monetary policy options at the Fed’s disposal. This result would be the best of both worlds: it would allow the Fed to be the ones to craft monetary policy from their expertise while ensuring that our representatives have a chance to review the effects of the monetary policy. Each of the committees ideally would consult other expert economists to field a variety of opinions on Fed’s policy, fostering a multi-faceted, open dialogue about monetary policy.
Secondly, I propose that any unconventional aspects of Fed policy, including quantitative easing and large loans to distressed companies, be subject to approval by all of Congress. These policies have not been adequately tested; it is necessary to have an open dialogue about the risks and rewards entailed in such a program.
Of course, some (mostly Democrats who trumpet government transparency, ironically enough) will argue that the Fed needs political independence so that it can do what is best for the economy. They will contend that such measures as the ones I’ve proposed will politicize and delegitimize the Fed, bending monetary policy to the whims of representatives uneducated about the economy and monetary policy. Yet such assertions run contrary to the facts at hand and our democratic traditions. They are nothing more than false arguments circulated by both the Fed and its supporters to defend the unconscionable concentration of power within one agency.
There is not a tradeoff between independence and efficacy, as many would allude to, because all organizations within the government are subject to review and are checked by other organizations. With my proposal, the Fed would continue to be the author of monetary policy, as it is now, but its policies will be subject to review by our elected representatives. Moreover, in accordance with our history and democratic traditions, decisions of such magnitude are only legitimate if they are derived from the democratic process of allowing stakeholders to voice their opinion. We need to ensure that the Fed is governing with the consent of the governed before it opens the Pandora’s Box of bad monetary policy.
The Federal Reserve is defined by a dichotomy between its immense power and its lack of accountability. Within the confines of a limited government operating under constitutional law, this is simply unacceptable. The American people deserve to know how U.S. monetary policy is crafted, and they deserve to have a voice in this critical function of their government.
This article presents the views of author Mike McVea, not necessarily those of the Georgetown University College Republicans or GUCR Board. This piece belongs solely to Mr. McVea and cannot be reproduced in any way without his approval. For more GUCR updates, like us on Facebook or follow us on Twitter.