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Views: The Federal Reserve: Audited, Transparent and Independent


Joel James
Thursday, April 1, 2010

As of this writing, legislative proposals to reform the regulation of the financial industry are in flux. The Federal Reserve figures prominently in these proposals and three crucial issues in the evolving legislation could impact the independence of the Federal Reserve System and its ability to fulfill its duties as the nation’s central bank. Specifically, these issues are:

  • auditing the Fed’s monetary policy process,
  • altering the Fed’s responsibilities for banking regulation and supervision, and
  • changing the governance structure of the Reserve banks.

The current structure of the Federal Reserve System combines the Federal Reserve Board, which is a centralized government agency, and the Reserve banks, which are regional corporations designed to fulfill the Federal Reserve’s legislative mandates. The private-public, centralized-decentralized character of the Federal Reserve lets the Fed make monetary policy decisions in the context of both short-term economic conditions and long-term economic considerations in the absence of political influence. A hallmark of the Fed’s analysis and research is that it does not have a political agenda but an economic one, thus allowing the pursuit of policies and research that the Fed believes are in the best interest of furthering the sustainability of the U.S. economy.

Transparency and Current Auditing

Through the Government Accountability Office (GAO), Congress can audit all parts of the Federal Reserve’s operations except for monetary policy and related areas explicitly exempted through a 1978 provision passed by Congress. Congress created the exemption to protect monetary policy from short-term political pressures and to support the Fed’s ability to effectively pursue mandated objectives of maximum employment and price stability. Some legislation looks to remove this exemption.

While these policy decisions are not audited per se, the Fed’s monetary policy decisions are transparent as they are immediately announced to the public and receive extensive commentary from academics and market participants. Full meeting transcripts are also later made public and, of course, the Chairman and other Fed staff can be called to testify before Congress. The current law provides the appropriate arms-length distance between political oversight and monetary policy. That distance is critical to the credibility of our commitment to stable prices in the marketplace.

Supervisory Role

Some legislative proposals consider removing the Federal Reserve from a bank supervision role, including oversight of state-charted member and bank holding companies. During the recent financial crisis, we were able to act quickly and expertly to address problems in the banking system and to stabilize key markets because we employ people with unparalleled expertise in the areas of economics, financial markets and regulation. Our continued role in banking supervision also provides an invaluable conduit for information necessary to carry out a core central bank responsibility, which is the lender of last resort. Hands-on experience as a regulator enables us to assess creditworthiness of borrowers as well as adequacy of collateral. Stabilizing the financial system through our discount window operations was amply demonstrated during the 9/11 tragedy and the recent global financial crisis.

Fed Independence

There are also proposals to change the Federal Reserve structure, for example, by calling for the President to appoint the Reserve Bank presidents or board chairmen with confirmation by the Senate. The Fed was created with a governmental part, a Wall Street part and a Main Street part to assure that the entire nation’s needs were considered in monetary policymaking. Changing the governance of individual Reserve Banks may have the paradoxical effect of reducing the role of Main Street in thinking about the financial system, credit conditions and the economy.

Currently, the board of directors at each Reserve Bank nominates its president and chairman who are subject to approval by the Board of Governors. The nine members of the Reserve Banks’ boards (three of whom are bankers) reside and work within their local Federal Reserve districts and provide valuable insight into current regional economic and financial conditions that statistics alone cannot. Subjecting Reserve Bank presidents and board members to the political process could significantly alter this balance of views.