In reform, a return to monetary policy
With the spotlight on the Federal Reserve in the wake of the financial crisis, the Obama administration and Congress have begun debating the Fed’s role in overseeing and regulating the financial sector. Among President Obama’s July recommendations for reform was an expanded role for the Fed, including oversight and expansive regulatory power over giant financial firms and systemic risk. Fed Chairman Ben Bernanke, in his Oct. 1 testimony to the House Financial Services Committee, echoed the White House’s desire for a broader regulatory mandate for the Federal Reserve. Yet while Congress agrees on the need for enhanced oversight and regulation in the financial sector, its concern with a perceived lack of transparency and accountability at the Fed has made it wary of expanding its powers.
Indeed, while there seems to be a remarkable consensus within Washington about the changes needed to fix the current regulatory system, experts and various branches of government differ on how best to achieve these reforms, and what role the Fed should play. In this debate, the ongoing disputes between Congress and the Fed over transparency and accountability are distracting from what experts see as the larger concern: ensuring that the Federal Reserve maintain its independence and focus on monetary policy.
New Roles for the Fed
The Fed plays an important role in times of crisis. Vincent Reinhart, former director of the Federal Reserve Board’s Division of Monetary Affairs, believes the Fed is uniquely situated to act quickly under these conditions. “There are many situations with no possibility for immediate action by Treasury or Congress, so it is appropriate for the Fed to act,” he explained to the HPR. However, the Fed’s involvement must be time-limited so as not to undermine its primary long-term goal of executing sound monetary policy. Reinhart argued that the Fed should only hold a loan on its balance sheet for a short while, perhaps a month or two, and then should transfer liability to the Treasury. Furthermore, Reinhart continued, Treasury should hold the loans because it is ultimately responsible to Congress, and Congress alone should have the power to determine whether to put taxpayer dollars at risk. Concerned about expansive Fed lending capabilities with little oversight, he maintained that, “Congress needs to be brought back into the deal.”
While these concerns over power and accountability dominate the current debate about the future of the Fed, a larger concern looms: whether expanded powers for the Fed would undermine its ability to carry out its monetary policy responsibilities. Alice Rivlin, the first director of the Congressional Budget Office and a former Federal Reserve Governor, insisted to the HPR that, “The main job of the Federal Reserve is, and should be, monetary policy.” While she believes the Fed is well equipped to look for systemic risks, and could successfully take on an expanded role, she is thus wary of giving it new tasks as a consolidated regulator.
Putting Monetary Policy First
Jon Faust, an economist at Johns Hopkins University, thinks along similar lines. He recognizes the importance of the Federal Reserve in times of crisis, but noted to the HPR that, “Most of the time, we need the Fed to run sound monetary policy. History has shown that can be a politically sensitive job, so the most important thing in any reform is to make sure we don’t threaten the independence of the Fed to conduct normal monetary policy during non-crisis times.” Reinhart concurred, worrying that, “Monetary policy is too important to risk trading off to other goals, and if you give the Fed too many functions, it, Congress, and the public will be confused about how it should balance them.”
So, while the debate in Washington about the future of the Federal Reserve centers on questions of blame for the financial meltdown, concern over a lack of Congressional oversight, and political jockeying for power between the branches of government, the key issue remains underappreciated. Lawmakers and government officials would do well to focus more on ensuring that the proposed reforms protect the Fed’s ability to set sound monetary policy, and do not sacrifice its main purpose for secondary roles of consumer protection and the regulation and oversight of financial institutions. With a ballooning deficit and real concerns about inflation, the Fed needs to be able to focus on fulfilling its principal duty.