The Fed under fire By Barry Eichengreen March 10, 2015 – Project Syndicate The Federal Reserve is under attack. Bills expansion of its balance sheet under the guise subjecting the United States’ central bank to of quantitative easing. “auditing” by the Government Accountability These decisions were controversial, and their Office are likely to be passed by both houses of advisability has been questioned – as it should Congress. Legislation that would tie how the be in a democracy. In turn, Fed officials have Fed sets interest rates to a predetermined sought to justify their actions, which is also the formula is also being considered. way a democracy should function. Anyone unaware of the incoming fire only had There is ample precedent for a Congressional to listen to the grilling Fed Chair Janet Yellen response. When the US last experienced a crisis received recently on Capitol Hill. Members of of this magnitude, in the 1930s, the Federal Congress criticized Yellen for meeting Reserve System similarly came under privately with the president and treasury Congressional scrutiny. The result was the secretary, and denounced her for weighing in Glass-Steagall Act of 1932 and 1933, which on issues tangential to monetary policy. gave the Fed more leeway in lending, and the Still others, like Richard Fisher, the outgoing Gold Reserve Act of 1934, which allowed it to president of the Dallas Fed, have inveighed disregard earlier gold-standard rules. against the special role of the Federal Reserve The Banking Act of 1935, as amended in 1942, Bank of New York. Reflecting the New York then shifted power from the Reserve Banks to Fed’s heavy regulatory responsibilities, owing the Board in Washington, DC, and confirmed to its proximity to the seat of finance, its the special role of the Federal Reserve Bank of president has a permanent seat on the Federal New York. Open Market Committee, the body that sets the Fed’s benchmark interest rate. This, its These reforms reflected an overwhelming detractors warn, privileges Wall Street in the consensus that the Fed had been derelict in operation of the Federal Reserve System. fulfilling its duties. It had failed to prevent the money supply from contracting in the early Finally, some object that bankers dominate the stages of the Great Depression. Heedless of its boards of directors of the regional Reserve responsibilities as an emergency lender, it had Banks, making it seem that the foxes are allowed the banking system to collapse. When guarding the henhouse. financial stability hung in the balance in 1933, This criticism reflects the fact that the United the Reserve Banks’ failure to cooperate States has just been through a major financial prevented effective action. crisis, in the course of which the Fed took a Given such incompetence, it is not surprising series of extraordinary steps. It helped bail out that subsequent reforms were far-reaching. But Bear Stearns, the government-backed mortgage these reforms went in precisely the opposite lenders Freddie Mac and Fannie Mae, and the direction from today’s proposed changes: insurance giant AIG. It extended dollar swap fewer limits on policy makers’ discretion, more lines not just to the Bank of England and the power to the Board, and a larger role for the European Central Bank but also to the central New York Fed, all to enable the Federal banks of Mexico, Brazil, Korea, and Singapore. Reserve System to react more quickly and And it embarked on an unprecedented robustly in a crisis. It is far from clear, in other words, that the right response to the latest crisis related to monetary policy. Their mandate is to is an abrupt about-face. maintain price and financial stability, as well as Ultimately, whether significant changes are maximum employment. The more intently Fed warranted should depend on whether the governors focus on their core responsibilities, central bank’s interventions in fact aggravated the more inclined politicians will be to respect the recent crisis, as they aggravated the crisis of their independence. the 1930s. But the Fed’s critics have been Finally, Fed officials should acknowledge that curiously nonspecific about what they regard as at least some of the critics’ suggestions have the Fed’s mistakes. And where they have been merit. For example, eliminating commercial specific, as with the accusation that the Fed was banks’ right to select a majority of each fomenting inflation, they have been entirely Reserve Bank’s board would be a useful step in wrong. the direction of greater openness and diversity. Fed officials, for their part, must better justify The Federal Reserve System has always been a their actions. While they would prefer not to re- work in progress. What the US needs now is litigate endlessly the events of 2008, continued progress in the right direction. criticism suggests that their decisions are still Barry Eichengreen is Professor of Economics at the not well understood and that officials must do University of California, Berkeley; Pitt Professor of more to explain them. American History and Institutions at the University of Cambridge; and a former senior policy adviser at the In addition, Fed officials should avoid International Monetary Fund. weighing in on issues that are only obliquely .