Restructuring the Fed

Jerome Powell speaking at an FOMC meeting
Jerome Powell, the only Republican governor on the Federal Reserve Board, has rightly claimed that a Fed audit would be “in violent conflict with the facts”.

Spearheaded by financial reformers such as Rand Paul, the movement to audit the Federal Reserve’s conduct has grown in recent years. One current proposal would subject the Fed’s monetary policy to Government Accountability Office audits. While this is aimed to prevent the creation of asset bubbles that we’ve seen from late-Greenspan, Bernanke, and Yellen, it poses additional problems for the US’s financial system.

Jerome Powell, the only Republican currently serving as a Federal Reserve Board governor, gave a speech on 9 February, expressing worry that an audit would produce “substantial risk of political interference”. Considering the atrocious left-wing, expansionary movement the Fed has made since Greenspan’s exit (QE and ZIRP), further politicization of central bank policy should be avoided at all costs. Powell added that Fed policy is most effective when “rendered independent of influence by elected officials”.

This false panacea does nothing to solve the structural problems that the Fed faces. Dallas Fed Chairman Richard Fisher argued that the Fed was “audited out the Wazoo”. While his statement isn’t entirely accurate as outside institutions have no direct control over the Fed’s open market operations, some truth lies in the claim. The Federal Reserve Reform Act of 1977 forced the central bank to “promote maximum employment, production, and price stability”, establishing direct policy objectives  for the first time. Since then, interest rate policy has become unstable in order to achieve these goals, often causing financial crises.

Aside from the poor policy decisions, which can only be repaired through the appointment of rational governors to the FRB, many structural problems exist within the Federal Reserve System. Many market analysts believe that too much power rests with the New York Fed. Assets and transfer volume are fragmented throughout each of the system’s 12 regional banks. Decreasing the number of banks to six (New York, Dallas, San Francisco, Saint Louis, Atlanta, and Chicago) would concentrate these indicators and decrease the relative power of the New York Fed. After the unsightly burden that Dodd-Frank placed on smaller financial institutions, a reduced number of regional banks could redirect their conduct to verifying the transactions of the largest holding companies, which are typically based in the six aforementioned cities.

To further inhibit the political implications placed on the Fed, the Presidents of the six regional banks should be given permanent Federal Open Market Committee voting power. Consolidation of the regional banks and new power in the FOMC will dramatically increase efficiency of the Federal Reserve System’s objectives. The new voting seats also bring a variety of views, notably that of Saint Louis Fed President James Bullard, who warned that failure to increase the federal funds rate would create “some risk” and other options would be “resolved in a violent way”.

Those that advocate abolition of the Federal Reserve fail to realize two key points. When a country has a nationalized currency, like the United States, a central bank is needed to ensure the limited stability of the currency. Combined with a fractional reserve banking system, a central bank provides liquidity to financial institutions.  Privatization of the world’s currencies is the best option of reform, however this is politically impossible for at least the next two decades. In the meantime, the Federal Reserve needs to be operating in the most efficient manner in order to ensure proper function of financial markets.

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21 thoughts on “Restructuring the Fed

  1. Richard Vessel March 2, 2015 / 8:25 am

    This article hits it right on the money. Our banking industry is one of the most regulated in the world which sort of tells you that our thousands of pages of regulations are not having their desired effect. The poor Fed policy is just a symptom, and the Fed’s structure needs to change to have regional banks play a bigger role.

  2. James_R March 2, 2015 / 9:15 am

    If our current 175,000 pages of byzantine federal regulations fail to contain any pertinent provisions that satisfactorily regulate the banking industry……….That must mean that we need an additional 175,000 pages. To me, that says government created our banking woes and needs to be distanced from any solution.

    • Jared Owen March 2, 2015 / 10:26 am

      So, what’s the reward of de regulating the banking industry, and how can that help Americans out?

      • James_R March 2, 2015 / 10:41 am

        The last piece of banking legislation that was passed a few weeks ago contained bailout provisions for derivatives written word for word by lobbyists working for Citigroup. The banking industry writes their own regulations. They love it when people like yourself demand more regulations.

        • Jared Owen March 2, 2015 / 4:04 pm

          Oh really do you have a source I can look at? I don’t think banks are very effective at regulating themselves, but if you think that then that’s great! However, I’d still like to see your source.

          • James_R March 2, 2015 / 4:05 pm

            This is a comment section, not a term paper. Do a simple google search and see it for yourself. The fact that you are demanding politicians with no banking expertise whatsoever regulate the criminal banking syndicates that they themselves created is exactly why we are in the situation we find ourselves in.

  3. SaltOnBacon March 2, 2015 / 9:48 am

    Interest rates are a doubled edged sword. Low interest rates cause retirees to tightening up and not spend. And as far as eliminating the $4T BS, the debt will just be forgiven.

    • Free Market Figher March 2, 2015 / 10:41 am

      Better not happen – that will end really badly for the people who try to pull that off.

  4. dennis March 2, 2015 / 11:11 am

    I think that Vega’s proposal would really help decentralize power from NY Fed. Dudley has come a tyrant and it needs to stop!

  5. QuantumThinker March 2, 2015 / 11:25 am

    Zach is right on everything but the audit. It should just be a pre-cursor to completely changing the Fed’s mission and role – to something nobody has to pay much attention to. They have turned economic forecasting into a Fed-watching spectacle. He’s right to have concern about making the Fed too political, but it already is!

  6. COLTPYTHON March 2, 2015 / 11:28 am

    See how all the mainstream economists turn this conversation into Congress controlling the Fed. Can someone explain to me what is so bad about an audit? Does anyone even know what an audit is?

    • Zach Vega March 2, 2015 / 11:39 am

      While Congressional influence of monetary policy through GAO audits isn’t horrible at the moment (the bubble would probably burst, but that needs to happen anyway), it opens up a Pandora’s box as to what actions the Fed will take. Some left-wing economists have proposed a massive expansion of the money supply to fund new welfare programs. Politicizing the Fed even more than it already is (*ahem* Yellen *ahem*) could cause horrible, catastrophic ideas like the aforementioned to become actual policy.

  7. Roland Deschain March 2, 2015 / 11:31 am

    The FED should be hamstrung…or strung up. Either way the GAO audit isn’t enough. The people deserve and need complete transparency from the FED. This objection only further solidifies the point that there is too much secrecy inside the most powerful bank in the world….You wanna resign now, or be fired later?

    • Tim Huks March 2, 2015 / 11:32 am

      Let’s just turn monetary policy over to the congress. They’ve done a great job in the past by screwing up banks with Dodd-Frank, issuing new mortgage requirements, and pushing manufacturing offshore with labor regulations!

  8. Jellin' with Yellen March 2, 2015 / 11:36 am

    Glad you can see into the future. The policies that the Fed undertook are unprecedented and the ultimate outcome is still unknown. If you’ve got some history to provide for your assertion, please provide it. And the spending was not done by the Fed, the congress has the purse strings.

    Fed=monetary policy.
    Congress=spending policy.

    The Fed just provided liquidity to the markets and kept interest rates low that allowed O-blama and crew to continue to borrow and claim that all is fine. Put the blame where blame is due, it’s on the elected officials in our gov’t.

  9. Joe Bender March 2, 2015 / 11:37 am

    This article pretty much says what I’m thinking. Nice timing too, with Plosser leaving Philly Fed.

    • Zach Vega March 2, 2015 / 11:42 am

      I was hoping that someone would get that. It seems that Patrick T. Harker is going to take a different approach, especially considering his unique origins.

  10. voreason3 March 2, 2015 / 11:43 am

    You want total economic chaos?

    Put the Fed under direct control of a Democratic congress.

  11. TheOne March 2, 2015 / 12:50 pm

    My main concern is that the FOMC will become like an elected committee under more Congressional involvement. The Fed does need to be changed to allow viewpoints other than the status quo.

  12. Joe Williams March 2, 2015 / 1:20 pm

    First of all, we do not know how the economy might have healed on its own.many believe ,and i am one of them that the federal reserve interfered in the healing process by not allowing the weaker portion of the economy to be cleansed thus allowing for future unimpeded growth. there is a feeling that many lame businesses that were poorly run should have been allowed to fail but did not .i believe this contributed to the slow recovery and lousy job formation and the system is loaded down with weak players that will eventually cause the next downturn. the second point is we have only seen average growth of 2% with massive asset bubbles that will soon collapse .the point is we do not know yet what the ultimate outcome will be until the federal reserve unwinds interest rates and rids itself of the 4 trillion dollar balance sheet

  13. Joel March 2, 2015 / 1:54 pm

    Zach, I’ve been reading your Twitter on and off for the past year. Your analysis is always of perfection, and this is of no exception. Good job identifying the problems the Fed faces.

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