Alan Blinder in CFR's Foreign Affairs: The Fed's Political Problem

by Alan Blinder | FOREIGN AFFAIRS
September 3, 2009

Summary - As the financial crisis continues, the U.S. Congress is considering a bill that would jeopardize the independence of the Federal Reserve. This is a shame. Monetary policy should be protected from congressional politics.

ALAN S. BLINDER is Gordon S. Rentschler Memorial Professor of Economics and Public Affairs at Princeton University and Director of Princeton's Center for Economic Policy Studies. He served on the White House Council of Economic Advisers from 1993 to 1994 and as Vice Chairman of the Board of Governors of the Federal Reserve System from 1994 to 1996.

In the midst of the ongoing financial crisis, Congress is now considering a bill that would subject the Federal Reserve to congressional audits. It would be a shame to let that happen. Some functions of government properly belong in the realm of technocracy (for example, drug approvals), and others belong in the realm of politics (for example, same-sex marriage). I first argued in the November/December 1997 issue of Foreign Affairs that the U.S. government was placing too many decisions in the political realm and too few in the technocratic one. In the 12 years since, I have become increasingly convinced of this.

The thought back then was inspired by the apparent success of the Federal Reserve System. A noteworthy creation of the Progressive Era, the Fed was designed to conduct monetary policy on decidedly nonpolitical grounds: it has only a vague legal mandate from Congress -- to pursue both "stable prices" and "maximum employment" -- and nearly complete discretion to fulfill its mission as it sees fit. Over the years, the Fed, protected from partisan political concerns, has been able to run a very capable -- which is not to say perfect -- monetary policy, almost certainly keeping inflation lower than politicians would have. Yet, despite this success, few, if any, U.S. government agencies today enjoy anything remotely close to the Fed's degree of insulation from politics. Maybe, I suggested in 1997, more should.

Since then, the Fed has scored some spectacular successes. It averted financial calamity in the United States as economies faltered throughout Asia in 1997-98; it steered the country through the post-2000 stock market crash with minimal damage; and, most recently, it took extraordinary measures to avert what its chair, Ben Bernanke, said might have become the Great Depression 2.0. But it has also suffered some spectacular failures. For example, it did not properly supervise banks in the run-up to the current crisis, nor did it protect consumers from predatory mortgage lenders.

Ironically, both the Federal Reserve's failure to prevent the crisis and its remarkable success in pulling the economy back from the brink have fueled Congress' hostility. Since it proved to be a poor regulator, some legislators are reasonably asking why they should give it additional regulatory powers, as the Obama administration's reform plan proposes. Others have accused the Fed of usurping congressional authority by engaging in back-door appropriations of taxpayer funds -- for example, when it used emergency loans to facilitate Bear Stearns' purchase by JPMorgan Chase and propped up AIG in 2008.

Congress' ire cuts across party lines, but it has been crystallized by Ron Paul (R-Tex.), an extreme libertarian and longtime foe of the Fed. He has, incredibly, persuaded almost two-thirds of the House of Representatives to co-sponsor a bill that would jeopardize the Fed's independence. The bill is titled, innocently enough, the Federal Reserve Transparency Act, which sounds like something everyone should favor. In fact, many have long advocated greater Federal Reserve transparency. And, incidentally, the Fed has become substantially more transparent over the past decade, such as by issuing explanatory statements with each policy decision and revealing more about its internal economic forecasts.

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