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"Audit the Fed"

ResponsiblyIrresponsible
Posts: 12,398
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2/11/2015 8:16:02 AM
Posted: 1 year ago
News headlines as late have been consumed by talk of Rand Paul's "Audit the Fed" proposal. I for one am vehemently opposed to any form of this bill, but I'd love to hear some arguments for it.

http://www.bloomberg.com...

If anyone wants to do a formal debate on it at some point, let me know. Though, for now, a forum on it is probably better than nothing.
~ResponsiblyIrresponsible

DDO's Economics Messiah
lannan13
Posts: 23,074
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2/11/2015 10:48:05 AM
Posted: 1 year ago
At 2/11/2015 8:16:02 AM, ResponsiblyIrresponsible wrote:
News headlines as late have been consumed by talk of Rand Paul's "Audit the Fed" proposal. I for one am vehemently opposed to any form of this bill, but I'd love to hear some arguments for it.

http://www.bloomberg.com...

If anyone wants to do a formal debate on it at some point, let me know. Though, for now, a forum on it is probably better than nothing.

I have been getting some newletters on it and I would like to see some tranparentcy on what they do fiscally and how the big banks make so much profit and how our fed has racked up so much debt.
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ResponsiblyIrresponsible
Posts: 12,398
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2/11/2015 11:27:54 AM
Posted: 1 year ago
At 2/11/2015 10:48:05 AM, lannan13 wrote:
At 2/11/2015 8:16:02 AM, ResponsiblyIrresponsible wrote:
News headlines as late have been consumed by talk of Rand Paul's "Audit the Fed" proposal. I for one am vehemently opposed to any form of this bill, but I'd love to hear some arguments for it.

http://www.bloomberg.com...

If anyone wants to do a formal debate on it at some point, let me know. Though, for now, a forum on it is probably better than nothing.

I have been getting some newletters on it and I would like to see some tranparentcy on what they do fiscally and how the big banks make so much profit and how our fed has racked up so much debt.

That sounds fair, but there are a few parts of that I take issue with.

First, transparency is great (within reasonable limits, as I'll get to it in a bit). The Fed has already significantly increased transparency after Ben Bernanke took over, and that's continued with Janet Yellen. For instance, the Fed didn't release a policy statement or communicate about policy until the early 2000s, but now does so regularly, holds four press conferences a year, a multitude of speeches, not counting interviews with voting members of the FOMC, etc. So the Fed has already been transparent not only about what it's doing, but about the logic underpinning its decisions.

Second, the Fed is already subjected to a series of audits, both the individual regional banks and the system as a whole. The GAO reviews its actions, its financial statements are audited annually, it releases its balance sheet weekly, etc.

More detail, if you're interested: http://www.federalreserve.gov...

Third, there's a difference between transparency and meddling in monetary policy decisions, as Rand Paul and his ilk would like to due because they haven't the slightest clue of how monetary policy works and need to appeal to the emotions of their ideologically entrenched base who, in all their tin-foiled-hat glory, actually have the temerity to claim that the government is rigging its book--I guess, overstating RGDP and understating inflation, which seems to violate a basic short-run Phillips curve you learn in Macro 101, but I digress.

The point is, there's been a myriad of research on the relationship between central bank independence and the efficacy of policy. We know, for instance, from a seminal paper by Alesina and Summers dating back to 1993 that there's a pronounced negative correlation between central bank independence and average inflation. The logic is that, if the central bank is beholden to political interests, whose sole goal is to be re-elected, it will pursue a "time inconsistency problem" of prioritizing the short run over its long-run price stability goal, and thus pursuing overly expansionary policy at the behest of politicians and their donors. That, by and of itself, would be highly destructive, because credibility is necessary for the successful implementation of policy--specifically anchoring inflation expectations, so if the Fed goes out and buys $3 trillion in Treasury and MBS to ward off a financial calamity, inflation won't soar out of control because the public expects the Fed to combat inflationary pressures, should they appear--and this is embedded in bond markets, nominal wage contracts, etc. Eroding the Fed's independence, however, thus giving way to an inflationary bias, would risk un-anchoring inflation expectations and leading to significant volatility not only in terms of wage contracts--meaning that paying off nominal debt contracts becomes trickier and people are likely to hold off spending and investing--but bond prices will fluctuate regular. Since the 10 year note (whose yield is currently collapsing, mind you) is considered a benchmark for a myriad of long-term rates, you'd see a number of interest rates--adjustable rate mortgages, etc.--moving up and down all over the map.

We could even take it a step further and even challenge Alesina's and Summer's prediction. After all, there are some, like Patricia Pullard of the Kansas City Fed, who argue that this negative correlation is nothing more than endogeneity--i.e., inflation-adverse central banks are more likely to be independent. But an argument that Scott Sumner has made, and I personally subscribe to given the source of this bill, is that we would actually see a sharp *decline* in inflation. But obviously there's a fundamental difference between a decline in inflation and long-run price stability, especially with headline measures of inflation hovering *below* 1 percent. House and Senate Republicans in particular are extremely hostile to monetary policy--though they don't understand it, in the slightest, and anyone with the slightest knowledge of it can tell you that--and would be more likely to clamor about "inflationary pressures" which are nonexistent. Much of that, I think, is a result of the fact that their constituents don't understand the difference between inflation and the cost of living.

The banks making so much profit and having an implicit subsidy upwards of $80 billion dollars--or even large if you look at Bank of International Settlements estimates of about, I believe, $300 billion, though that's on a global scale--is almost entirely removed from monetary policy. You can say that banks holding excess reserves "profited" from QE, but it did nothing more than swell their balance sheets because they held onto base money. When the economy is bad, loan demand is bad and investment opportunities suck, which is why M1 and M2 grew *significantly,* embarrassingly less than the increase in the monetary base, which is why citing an expansion of the Fed's balance sheet as evidence of a need for "oversight" is extremely misleading.

Finally, and I think this is a misconception amongst many, the Fed doesn't use taxpayer dollars. It never has and never will. All of its "profits" are remittances to the Treasury, and come straight from its portfolio. It just turned over a record high amount, actually, of about $98 or so billion.

Oh, and I want to make one last point on transparency: there's a significant diminishing returns to it. Transparency sounds amazing, but in reality, it ties the heads of monetary policymakers and leads to volatility down the road. For instance, if the Fed's interest-rate negotiations were audited, it wouldn't be able to monitor data internally. The public would be able to see exactly what the Fed is thinking, and would price financial assets accordingly. This sounds all fine and good, but if something changes--i.e., data changes, as does the policy--markets would throw a tantrum,and the credibility of the Fed as an independent institution would markedly tank.

A good example was the 2013 Taper Tantrum. In May and June, Bernanke gave a few speeches where he hinted at the coming moderating of large-scale asset purchases. Markets took this as liftoff forward guidance. 10 year Treasuries and mortgages rates rose about 100 basis points, capital inflows moved from emerging markets to U.S. assets, the dollar appreciated, etc. In other words, disaster ensued. That's what you'll get from these GOP proposals, whether it's "Audit the Fed," or the FRAT Act, which would compel the Fed to model policy in accordance with a Taylor-Type rule. They just won't work.
~ResponsiblyIrresponsible

DDO's Economics Messiah