It’s no secret that libertarians love to hate the Federal Reserve. After all, we tend to regard power with suspicion, and no institution wields more power over the economy than the Fed. Given the unprecedented actions of the Fed in response to the financial crisis and the overall mystery and complexity that veils monetary policy, it’s understandable that more than just libertarians are now concerned. More transparency in monetary policy and a clearer definition of the Fed’s powers are clearly needed. There are already methods in place to do this, but they need to be reformed for both economic and practical reasons.

The Federal Reserve System was created in 1913 with the goal of providing a more stable and flexible monetary and financial system at a time when banking panics were a common occurrence and caused a lot of economic distress. The Fed has evolved over time, and its current objectives of maximum employment, stable prices, and moderate long-term interest rates are mandated by statute. Although the Fed and its statutory goals were created by Congress, the Fed has a great deal of independence in the policies choices it makes in pursuit of these goals.

Since the financial crisis, the public and Congress have demanded more accountability and transparency, a worthy cause as monetary policy has entered uncharted territory. The Federal Reserve Transparency Act (FRTA) has been proposed to deal with these issues.

This type of audit, while well-intentioned, is misguided and frankly bad economics.

Currently, the Fed’s financial statements are independently audited annually, the Fed Chairman and other Fed officials are required to testify before Congress on a regular basis, and an annual report is provided to Congress. Additionally, the Federal Open Market Committee (FOMC) publishes a statement right after each FOMC meeting that describes the Committee’s views on the economic outlook, and explaining its policy decisions.

In addition to mandating a more thorough one-time audit of the Fed, the FRTA would require the Fed publish its transactions with banks online and would expand the regular audits to include the internal deliberations, communications, and details of monetary policy activities. If this bill were passed, there is great potential that the unintended consequences would actually create more economic problems. There are already concerns over the current politicization of the Fed, and the expanded scope of audits proposed in this bill would only insert more political influence into the monetary policy decision making process, go beyond accountability for goals, and threaten the independence of the Federal Reserve.

Why is the independence of the Federal Reserve important? Why shouldn’t Congress have a hand in monetary policy actions? The Fed was specifically designed to maintain as much independence from the political process as possible… and with good reason! Effective monetary policy must be concerned with long-run goals, not short-term political gain. Although the Fed ultimately does answer to Congress and the people in terms of its mandated goals, there is a difference between being accountable for achieving goals and actually allowing Congress to insert itself into the monetary policy making process.

When political concerns begin to impact monetary policy makers, they will behave more like politicians. The incentive to set policy that is in the long-term interest of the public is reduced. Monetary policy makers will instead behave in the interests of the politicians in power. While monetary policy is certainly not free of political influence, the potential for political influence under the FRTA is decidedly more pronounced.

If you have followed politics for any length of time, you don’t need me to tell you that the short-sighted bias of this political influence has negative consequences. If you don’t believe me, just check out the empirical evidence showing that decreased central bank independence leads to inflationary monetary policy, while central bank independence is key to long-term price stability (low and stable inflation). That’s because political influence tends to be biased towards stimulating the economy in the short-term with inflationary policy even at the expense of long-term goals. Still, Congressional proponents of the Federal Reserve Transparency Act continue to cite concerns about inflation as a reason to give them more control of the Fed!

What we shouldn’t forget is that although concern over long-term inflation is the hot topic of today, we can’t trust that it will always override other political goals for Congress. Given increased influence over monetary policy, the temptation to use that power for personal gain would always be present. For more of an elaboration about that concern, read this.

While there is definitely a strong argument for reforming the Fed, there is no reason to resort to the politicization of the monetary policy-making process. I genuinely sympathize with many of the sentiments towards the Fed and its lack of accessibility and accountability, but there are some things that just shouldn’t be democratic. The making of monetary policy is one of them. No matter how much you dislike the Fed, you can be certain that giving Congress more power over it will not be an improvement. The changes proposed under the Federal Reserve Transparency Act do not address the real problems, and the potential unintended consequences of inserting more political influence into monetary policy are too dangerous to justify the risks associated with them.

That doesn’t mean that Congress and the public should do nothing. There are alternative actions that can be taken to improve the Fed. In his article, “What Should Central Banks Do?”, the prominent and well-respected economist Frederic Mishkin offers some constructive policy suggestions that take great strides in addressing the concerns of accountability and transparency without threatening the valuable independence of the Fed.

Among these suggestions are making long-run price stability the overriding mandated goal of monetary policy and establishing an explicit inflation goal. These two changes are a great start that would address inflation concerns and provide a means for accountability. The idea advocated by Mishkin to balance independence with accountability is with a central bank that is goal-dependent (the goals are determined by Congress), yet instrument-independent (the instruments used to achieve those goals are determined by the central bank without meddling by Congress). This distinction is important because although Congress and the American people have an interest in specifying the goals of monetary policy, neither has expertise in actually conducting that policy and the incentives are different when political motivation is involved.

Mishkin’s ideas are just one possibility to be considered. The FTRA is facing the likely fate of a quick death in the Senate, but with public sentiment on the side of reforming the Fed, now is the time to introduce reasonable alternatives with a solid economic basis to make progress towards resolving the problems. That means abandoning idealistic ramblings about ending the Fed and instead focusing on using economic data to propose feasible reform that will improve the institution in tangible ways.

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  • Matt Wavle

    You don’t reform a cancer, you cut it out, you remove it, you eradicate it. I challenge you to look at these two charts, then decide whether or not the fed is doing things as well or better than the free market. Either way shouldn’t the moneytary policies that affect us the most be transparent to all? Between Nov 10th, 2013 and Oct 5th, 2014 bitcoin increased in value about 2.5% in those 11 months.

    What about Gold? According to Gold lost 11.7% of its value (compared to the US Dollar) during the same 11 month period.

    Knowing this, the fact that people continue to buy Gold shows a serious mistrust in those permitted to meddle with the US Dollar.

    NOT auditing the Fed seems much more of a Statist opinion than a Freedom from Government one

    • Brittney Wheeler

      Matt, I agree that an increase in the value of gold and bitcoin could indicate a lack of trust in the Fed. Trust in the stability of a currency is very important, but how is giving Congress more influence actually going to restore that trust? What I am saying is that the lack of trust in the dollar will only be worsened by giving Congress more influence and is really the opposite of freedom from government.

      Using your metaphor, a doctor deals with cancer in the way that is most likely to deal with the problem with the least harm to the patient. If you are suggesting that the Fed should be eradicated, that is equivalent to a doctor simply removing the cancer with no regard for the invasiveness of the procedure and its impact on the patient.

      I am not against alternatives (such as crypto-currencies) if they prove to be effective, but only time and research will tell. In the meantime, we should reform the Fed in ways that will improve its ability to perform its intended function.

      • William Bruce

        Fun with Platonic political analogies: If the oncologist is having an affair with your spouse, should you continue to receive treatment from them?

  • Nicko

    It is important to audit the Fed; however, to be fair we need to make clear that the lack of transparency is not exclusive to the Fed. In general central banks have incentives to communicate strategically (and misrepresent private information) rather than in a transparent manner, due to the effect of public announcements on market expectations and, in turn, the effect of expectations on economic stability. A more detailed explanation and empirical evidence supporting it can be found in a recently published journal article:

  • Jeff Hamilton

    This is a great argument for why we should just move to a strong republic with clearly defined rules with high transparency and accountability, and just throw democracy out the window entirely. There is no reason this argument regarding “long-term” rationalization of society cannot apply to just about anything and cannot be clearly be clearly defined in the same manner your propose. Democracy serves short-term corrupt gain in all scenarios, not just monetary policy. People have to realize that democracy has nothing to do with freedom, and that a free people are not subject to the arbitrary whims on anyone, be it their peers, people elected by their peers, or a dictator all the same.

  • Aaron Michel

    The history of the creation and existence of the current central bank, and history of prior central banks in this country, suggest that there is no independence from politics, that the central bank is picking winners and losers, just as the government does with fiscal policies, that at least with Congressional Keynesianism, it is done by elected officials in an open forum in cspan and public notice requirements. This seems to undermine your main premise.
    This history also rebuts the premise that government intervention, whether monetary or fiscal, is routinely based upon unrealistic goals and produces more harm than good. Research from Austrian economists is quite abundant on the fallacy of the Taylor Rule and even Milton Friedman’s early suggestion of a fixed rate.
    And then there is the more recent Deformations book by Stockman talking about the politics of monetary policy and fiscal policy and false assumptions in the full employment model of budgeting adopted by the two parties in the 60’s once they got that old man Eisenhower out of the way.
    You also seem to have a mind set of there being experiment by the government only because we can’t trust you personally to make those decisions about your affairs – you need government to make those decisions for you. This nanny-ism is inconsistent with Libertarianism. If I were Murray Rothbard, it think I would have a field day with this article.

  • Story Time With Jesus

    For the entirety of the Bretton Woods period, worker compensation was very strongly correlated with worker productivity. When productivity went up, workers were rewarded for it. Starting in 1971 when Bretton Woods ended and the value of the dollar was controlled completely by the Fed, the relationship between worker compensation and worker productivity ended too, and there is now no relationship between the two. The Fed is the problem.