To Whom Is the Fed Accountable?

Former Federal Reserve Chairs Volcker, Greenspan, Bernanke, and Yellen published an article earlier this month titled “America Needs an Independent Fed.” They cautioned against political interference in the conduct of monetary policy. The former central bank chiefs are clearly worried about interference in Fed operations by President Trump. They write that “an economy is strongest and functions best when the central bank acts independently of short-term political pressures and relies solely on sound economic principles and data.” 

They are right to be worried. Politicians on short-term election cycles should be kept as far away from the printing press as possible.

Their contention that “Congress sets the Fed’s powers” and thus the Fed is accountable to Congress sits on a much shakier foundation, however. This is so in theory, but not in practice. Aside from the pantomime of Fed officials receiving an occasional dressing down by Congress, central bankers are almost completely unaccountable to the American public or their elected representatives. 

Why is that? For one, Fed officials are experts in macroeconomics, monetary economics, and financial economics. Members of Congress are usually generalists, lacking the training required to evaluate the Fed’s actions. It is a kind of principal-agent problem. The Fed (agent) is supposed to serve the public (principal), but the public lacks the know-how to evaluate whether the Fed is doing its job well. As a result, the Fed can get away with major blunders, imposing significant costs on the American economy. 

There was no meaningful oversight of the Fed when then-Chairman Greenspan used expansionary monetary policy to keep market interest rates too low for too long, fueling the asset bubble that would burst in 2007. There was no meaningful oversight of the Fed when then-Chairman Bernanke, in conjunction with the Treasury, oversaw a massive series of emergency programs to bail out irresponsible financial institutions. And there is no meaningful oversight now, as the Fed maintains its oversized balance sheet rather than taking meaningful steps toward monetary policy normalization.

Here is the dilemma. We do not want elected officials to police the monetary policy makers. But monetary policy makers have clearly demonstrated that they are incapable of policing themselves. 

Fortunately, there is another option. Congress can pass additional legislation that is more specific and binding than the current “dual mandate” of full employment and price stability, which is far too vague. The Fed needs a specific goal. And there must be well-established consequences for central bankers when the Fed fails to meet that goal. 

In fact, the best option would be a constitutional amendment for monetary policy. A constitutional amendment would enable Congress to discipline the Fed (outcomes are easier to observe and understand than processes, so the expert-knowledge problem would be mitigated). At the same time, it would also allow Fed officials substantial freedom in day-to-day operations. 

In a constitutional democracy such as the United States, no public authority may judge and justify itself. Up until now, the Fed has done precisely that. To achieve responsible monetary policy while maintaining true self-governance, we need a firm and clear rule for monetary policy that the Fed itself cannot change. Otherwise, Fed policy will continue to drift between political control and no control at all.