WASHINGTON – With the Federal Reserve in its centennial year, Fed chair nominee Janet Yellen facing a confirmation vote in the Senate, and questions circling around about when the central bank will scale back its bond purchases, many policy experts and lawmakers are keen on introducing some changes to the institution.
The Fed is currently spending $85 billion a month buying financial assets in the markets to lower long-term interest rates. The program, known as quantitative easing (QE), has quadrupled the Fed’s balance sheet to $3.8 trillion. The purpose of QE is to flood the banking system with cash to promote credit growth and boost the economy and employment.
Critics worry that QE is creating asset bubbles and distorting the market for government debt. They also argue that the Fed’s program risks stoking runaway inflation.
By reducing the supply of safe assets such as Treasuries, QE has forced investors to buy riskier assets such as stocks, which have enjoyed a significant rally under the program.
“While Wall Street has been roaring, Main Street has been left behind,” Chairman of the Joint Economic Committee Kevin Brady (R-Texas) said at a Cato Institute conference about the role of the Fed.
Brady said the current monetary policy regime is tilting the playing field in favor of Wall Street and away from average working families in America.
“We live now in a world that I would call the opposite market, where the job numbers come in each month or the quarterly economic numbers come in, and if they’re bad the market rallies because Fed stimulus will continue,” he said. “That can’t be the sign of a healthy economic recovery here in the United States or around the world.”
Brady said inflation might reach the economy when banks start lending all the dollars the Fed has injected into the banking system.
“Open market policies have created the conditions that might create the next financial bubble in stocks,” he said. “The excess reserves of the Fed’s balance sheets are the fuel for inflation.”
The Federal Open Market Committee, the Fed’s policy-setting body, is expected to start debating when to begin cutting back on its program over the next several meetings.
Brady said the prevailing view among lawmakers in Washington is that the Fed should manage nearly every aspect of the U.S. economy.
“Others, like myself, think the Fed should create a financial climate where the market is allowed to work,” he said, “where the Fed doesn’t pick winners and losers, especially among the financial markets, and families have confidence that their hard work and their savings will be preserved through maintaining the purchasing power of the dollar over time.”
Brady has proposed legislation that would create a bipartisan commission that would engage in a performance review of the Fed, exploring how well it has met its stated goals and what those goals should be. The Texas representative has called for everything to be on the table in the review of the Fed’s mandate.
The Centennial Monetary Commission would first start by looking backward, reviewing America’s economic performance since the Fed’s creation in terms of output, employment, prices, and financial stability.
The commission would evaluate a range of regimes, including price-level targeting, inflation-rate targeting, nominal GDP targeting, the use of monetary rules, and the gold standard.
The Fed itself emerged in 1913 from a National Monetary Commission created in the aftermath of the Panic of 1907 to examine the problems of the banking system. In 1977, Congress changed the monetary mandate of the Fed to a dual mandate for maximum employment and stable prices.
Brady’s bill is not a direct attack on the Fed that has been launched by other critics of the central bank, like former Rep. Ron Paul, who called for the elimination of the central bank altogether.
Instead, the proposal aims to be a more pragmatic approach.
Brady proposes a 14-member bipartisan commission, led by the chairman and ranking member of the Joint Economic Committee. Six Democrats and six Republicans, half of them legislators and half of them appointees, would comprise the panel. The Fed and the Treasury would each appoint one non-voting member.
The commission would be tasked with making recommendations, but Congress would still have to vote on anything the group proposed.
He envisions the commission to be “brutally bipartisan” with both parties contributing to a discussion about what the Fed’s role should be in the future.
“It has to be equally balanced between parties, equally balanced between policymakers within Congress and bright minds and thinkers outside of Congress. It needs to be a fair fight with the best and brightest ideas on monetary policy going forward,” Brady said.
By law, the Fed is directed to both maximize employment and minimize inflation – commonly called its “dual mandate.” This has led to confusion whether the Fed is paying more attention to price stability or labor market conditions at any given time.
Some Republicans have called for changing the Fed’s congressionally set mandate to one that focuses solely on inflation, but those efforts do not have support among Democrats.
At the event, Philadelphia Federal Reserve Bank President Charles Plosser said the Fed needs to stop trying to influence short-term changes in the labor market and instead focus on what it can control – inflation.
“I have concluded that it would be appropriate to redefine the Fed’s monetary policy goals to focus solely, or at least primarily, on price stability,” he said.
He said unsuccessful efforts to influence the unemployment rate could undermine the public’s confidence in the central bank and its legitimacy and independence.
Plosser also called for broader limits to the Fed’s authority, saying that the central bank should be restricted to purchases of Treasury securities and should be required to follow “a systematic, rule-like approach” to policy.
“This would limit the ability of the Fed to engage in credit policies that target specific industries…such programs to allocate credit rightfully belong in the realm of the fiscal authorities – not the central bank,” he said.
Plosser said changing the Fed’s mandate would improve the working of monetary policy, which had become distorted after policymakers sought new tools to deal with the financial crisis and its aftermath.
“Assigning multiple objectives for the central bank opens the door to highly discretionary policies,” Plosser said. The result of this, he said, is that officials can justify policymaking “by shifting the focus or rationale for action from goal to goal.”
The Senate Banking Committee voted last month to send Yellen’s nomination to the full Senate for consideration.
Sen. Rand Paul (R-Ky.) said he will oppose Yellen’s nomination unless he receives consideration of his measure, the so-called Audit the Fed bill, requiring a public audit of the Federal Reserve. Although Paul is not on the panel, half of the Republicans on the committee co-sponsored his bill.
Similar legislation, authored by his father, Ron Paul, was introduced by Rep. Paul Broun (R-Ga.) in the House earlier this year and currently has more than 100 co-sponsors.
The Federal Reserve Transparency Act would end restrictions on Government Accountability Office audits of the Federal Reserve. Additionally, the bill would give Congress oversight of the Fed’s credit facilities, securities purchases, and quantitative easing activities.
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