What to Do With the Fed

A lot of questions are being asked about the Federal Reserve—when talk of health care third ways and the new green revolution aren’t at the plate. The White House proposal last week for shaking up the regulatory structure calls for a lot of new powers being transferred to the Fed, including increased bank oversight powers and as the teeth for a systemic risk council. This sparked immediate concern from members of Congress, and a lot of ire from those who think the Fed caused the problems by mismanaging monetary policy. In the midst of the debate, here are some questions to think about:

  • Assuming that some agency is going to get systemic risk authority, is there a better group than the Fed? They are the most independent, well staffed organization. They have also shown, even with all the bailout shenanigans, pretty stable reserve and caution when it comes to interfering in the markets. They let the Bear Stearns situation go down to the wire, and even then would have let it go under if not for JPMorgan Chase. And the whole monetary policy screw up was a really a conservative move (albeit, a wrong one). When it comes to systemic risk oversight, a big problem is that anything this authority says will be taken as gospel truth and seriously skew the market. When a systemic risk regulator points out a problem, the markets will react violently. So, if this bad idea comes to fruition, some of the problems can be mitigated by giving control to a cautious regulator.
  • Can the army of economists and experts at the Fed really do everything Washington asks of them? We need to have reserved expectations, because the reality is that another recession is guaranteed after this economy bounces back. The business cycle is inevitable in this financial structure. And it is a good thing. Recessions aren’t inherently bad, they are a reordering of things, because no agency or group of officials can really manage the whole economy. So, even with increased powers to the Fed, the likely outcome won’t be prevention of future economic downturns.
  • Do we really want to threaten the independence of the Fed? I don’t think giving the Federal Reserve more power necessarily limits their independence as some have said, but I do think the concern is valid. One of the hallmarks of the American financial system is a central bank that does not have to deal with political, bureaucratic games. To be sure there are games they play, and they aren’t completely out of reach of Congress and 1600 Penn Ave, but the influence is minimized by their quasi-private status. And anyone concerned that this independence is being threatened understands that it would be a bad thing to bring monetary policy under the same umbrella as foreign policy, health care policy, transportation policy, and every other policy that is skewed by special interests lobbying self serving politicians.

In related news, the FMOC has some important decisions to make this week on long-term interest rates:

“The Fed is boxed in. The slack in the economy that is likely to persist for a very long time suggests the need for stimulative monetary policy to lower long-term interest rates through the purchase of Treasurys. The fiscal situation argues against this policy action, because it would weaken the Fed’s inflation-fighting credibility. How can the Fed get out of the box and pursue the expansionary monetary policy that is needed right now? The answer is that the Obama administration and Congress have to get serious about long-run fiscal sustainability.”

Read the rest of Columbia professor Frederic Mishkin’s WSJ commentary for more thoughts on the interest rate situation.