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Auditing the Fed

Tuesday, February 15, 2011

Senator Rand Paul and Representative Ron Paul are right to seek increased oversight of the Federal Reserve’s monetary policy, but their legislation is an inefficient means to that end.

The congressional Pauls, Representative Ron and his son Senator Rand, have introduced legislation to lift the 33-year-old prohibition on Government Accountability Office (GAO) audits of the Federal Reserve’s monetary policy. The idea is to increase oversight of a Fed that, letting no part of a crisis go unexploited, has significantly expanded the scale and scope of its activities.

The Pauls might think greater scrutiny will limit the risks of giving an institution unlimited access to the monetary printing press. They probably also find some self-satisfaction in reining in an institution that never seemed to treat the elder Paul seriously for three decades.

The heat of the public’s anger toward the Fed might generate “wind beneath the wings” of this proposal. But that anger can be channeled much more productively. GAO audits can be related directly to existing precedent regarding congressional  oversight of monetary policy, and in a manner more difficult for the Fed to protest. And that is an important consideration. Over the years, the Fed has shown extraordinary skill in deflecting attempts to tighten oversight.

Legislators would not have to uncritically accept the analysis handed down on high from Fed technicians.

Two features shape an audit of monetary policy. First, the GAO is a competent organization that has good economists on its payroll and access to first-rate outside help. It has also survived in Washington for 90 years by being even-handed—sometimes painfully so. Second, while the Fed might get seriously off track on rare occasions, usually its setting of monetary policy finds support among some economists, somewhere.

Thus, if the GAO were called in to audit the Fed’s monetary policy, it would almost surely issue a professional report providing predictions of various economic models and a range of recommendations from academic and market participants. The then-current stance of Fed policy would fall somewhere within that range. With a bit of reverse engineering, the GAO would also likely report the alignment of related events, making that current stance of policy appear appropriate.

Anodyne though it may be, legislators would find this product useful. In particular, they would not have to uncritically accept the analysis handed down on high from Fed technicians.

The legitimate source of Fed concern is not the result of a GAO inquiry but rather the publicity of the process.

How could this be inimical to the Fed’s independence? A cynic might suggest that the Fed likes the current balance of expertise, with its elite corps of economists generating reports that harried legislative assistants on the Hill must evaluate. GAO economists might not pack the punch of the more highly compensated Fed staff, but they would not be punching over their weight in providing an understandable assessment of Fed policy.

More likely, the legitimate source of Fed concern is not the result of a GAO inquiry, but rather the publicity of the process. Senators and representatives frequently write letters and give floor speeches criticizing the Fed. Those criticisms almost always sink beneath the flood of press releases flowing from Capitol Hill. A GAO audit, however, which can be requested by any committee or subcommittee of the Senate or House or written into law, gets attention. Moreover, it generates multiple media events—of the sort that politicians love—as it is requested, published, and responded to. And the predictable evenhandedness of the GAO product will justify the Fed’s position and provide fodder for its critics. Thus, the Fed worries that freeing the GAO to audit monetary policy erects a convenient public platform for criticism that legislators will mount with increasing frequency.

While the Fed might get seriously off track on rare occasions, usually its setting of monetary policy finds support among some economists, somewhere.

The Fed has a point. A GAO audit is costly, both for the GAO and its subject, and the value of any one report will decrease as the overall number proliferates. But to argue that many reports are too much is not to say that some would be unhelpful.

Congress gave the Fed independence in return for accountability; the GAO, performing its legislated mission, can help Congress conduct that necessary oversight. But ad hoc review is an inefficient means to that end. Rather, legislation should require a biannual GAO audit of U.S. monetary policy to be submitted to Congress one week before the chairman of the Federal Reserve goes to the Hill to present his semiannual monetary policy report. Armed with the report and some time to prepare, members of the oversight committees (the Senate Committee on Banking, Housing, and Urban Development and the House Financial Services Committee) would be able to delve into substantive issues. For its part, the Fed would have no grounds to complain about improving the main mechanism for it to account for its actions.

The Pauls are right that increased oversight of monetary policy would be useful. At the same time, so is recognizing costs and diminishing returns. They can achieve their aim with modestly trimmed legislation.

Vincent Reinhart, a former director of monetary affairs at the Federal Reserve, is a resident scholar at the American Enterprise Institute.

FURTHER READING: Reinhart makes “The Case for Quantitative Easing,” says many are “Getting Lehman Profoundly Wrong,” and discusses “Setting the Table for Fiscal Restraint.” Vincent and Carmen Reinhart say it is “Time to End the Denial over Mortgage Debt” and that, when it comes to the Fed, “Pride Goes Before a Fall.”

Image by Rob Green/Bergman Group.

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