David R. Henderson  

Audit the Fed, or End It?

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The Congressman I admire most, Ron Paul, is advocating that the Federal Reserve Bank be audited. Is this a good idea? I think there's one obvious plus and there are two less-obvious minuses.

The obvious plus is that an organization of bureaucrats that is used to not giving much information to Congress and to Americans in general would be required to open its books. Whenever a bureaucrat is humbled, all other things equal, that's a good thing.

Now, to the minuses. The first minus flows directly from the one plus. Much as some of us might enjoy seeing unelected bureaucrats squirm, the purpose seems to be, and the likely result would be, to make the Fed less independent. But a lot of research in the last 15 years or so, including work done by Alberto Alesina and Larry Summers [pdf.], finds that the more independent a central bank is, the lower is its inflation rate. So an ironic effect of auditing the Fed and reducing its independence could well be to raise the inflation rate.

The second minus is related to the first. The whole idea of a having one federal agency audit another typically excites mainly inside-the-Beltway people. Remember that Ron Paul will not be conducting the audit and that the "consumers" of the audit, Congress, are not 534 Ron Paul clones. It could not only lead to the first minus above, but could distract from discussion of more serious reforms such as ending the Fed.

One final point that is neither a plus nor a minus. The Fed, for all its secretiveness, is by no means the most secret government agency in Washington. I'm not talking about the obvious deep-cover organizations like the CIA or the National Security Agency. I'm talking about rank-and-file agencies like the Treasury Department, the EPA, the Department of Energy. Are they required to provide less information about their activities than the Fed is now required to provide? It's not obvious to me that they are.

Postscript: I enjoyed the interview that an anonymous (of course) interviewer with The Economist did with Ron Paul. My favorite line comes at the 10:24 point when they are discussing a world without the Fed.

The Economist: But who would control interest rates?
Ron Paul: The market. What's so strange about that?


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CATEGORIES: Book Club , Monetary Policy



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The author at RSSted Development in a related article titled Don’t audit the Fed, and keep away from that creepy guy writes:
    I’m always surprised to see smart people that I admire, like Dave Henderson, say nice things about Ron Paul. I first saw Ron Paul in a video before I knew anything about him. Despite what he was saying, he came across like the crazy uncle that ev... [Tracked on July 18, 2009 11:05 PM]
COMMENTS (14 to date)
H writes:

I am not that familiar with Mr. Paul's views but how exactly would you end the Fed?? Imagine libertarians controlled the white house, the senate and the congress how would you get rid of the Fed?

Lance Cahill writes:

David,

The bill, as it is currently written, is poorly written. It's written in a very broad manner, and would essentially compromise the independence of the Federal Reserve by repealing certain protections that exist when it is inspected by the Comptroller.

For example, this whole section would be repealed:

"Audits of the Federal Reserve Board and Federal reserve banks may not include—

(1) transactions for or with a foreign central bank, government of a foreign country, or nonprivate international financing organization;
(2) deliberations, decisions, or actions on monetary policy matters, including discount window operations, reserves of member banks, securities credit, interest on deposits, and open market operations;
(3) transactions made under the direction of the Federal Open Market Committee; or
(4) a part of a discussion or communication among or between members of the Board of Governors and officers and employees of the Federal Reserve System related to clauses (1)–(3) of this subsection."

Especially concerning is (2), as if the bill were to pass, it would allow the GAO to pass policy judgments on the Fed's recent actions.

Is it truly fruitful to make more financial institutions more skittish in coming to the discount window if they are have liquidity problems?

It's nothing short of political grandstanding, as the very little it will accomplish (towards the goals Rep. Paul has) will be outweighed by the protections that will be repealed.

BlackSheep writes:

H, you wouldn't abolish it from day to night of course. I imagine you'd start by allowing some alternative form of money to circulate.

John V writes:

I'm confused by what this will actually do. From what I've read, things talk about making suggestions and that sort of stuff. Where is the non-independence coming from? Does "pass policy judgments" mean change policy?

Bob Murphy writes:

David,

I share your concerns that this audit movement might end up badly; I don't trust Congress to "reform" the financial sector generally, so why would I trust it to "reform" the way the Fed does business?

However, I think you're wrong about the level of secrecy. If Congress asks the head of the EPA to tell them where they are spending billions of dollars, can the head of EPA just say, "No, I feel that telling you that would be counterproductive to our goal of protecting the environment"? Because that's what Bernanke told Congress last December.

RD writes:

I don't know what people expect to find out or to happen with this audit. Doesn't the Fed already release its balance sheet? Isn't the only likely alternative to Fed "independence" having Congress get more involved in monetary policy. Ending the Fed is not even remotely close to being a realistic option.

David R. Henderson writes:

Bob Murphy writes,
However, I think you're wrong about the level of secrecy. If Congress asks the head of the EPA to tell them where they are spending billions of dollars, can the head of EPA just say, "No, I feel that telling you that would be counterproductive to our goal of protecting the environment"? Because that's what Bernanke told Congress last December.

Good point. I may have overstated.
David

Devin Snead writes:

I definitely agree with your plus and first minus. The bill is watered down, as one would expect it to be. I don't know about the second minus. Even though the Fed probably discloses more information than agencies like the EPA and the Treasury, it still doesn't follow that the Fed is less secretive. The Federal Reserve System is easily one of the most powerful organizations in the entire world, and there's no telling what kind of secrets they have.

I would add one more plus. Even though H.R. 1207 isn't what we would like, the fact that the Federal Reserve is a big issue now is a very good sign. The more people that actually talk about the Fed, the better off we will be.

Harkins writes:

What does the Alesina/Summers paper show other than that bankers prefer a slightly lower inflation rate than politicians?
Maybe the Fed should be independent of defunct economists. Good luck with that. Just give the Fed to Barney Frank and let nature do the rest.

Radford Neal writes:

I don't know what people expect to find out or to happen with this audit. Doesn't the Fed already release its balance sheet? Isn't the only likely alternative to Fed "independence" having Congress get more involved in monetary policy.

Umm... isn't it normal that one doesn't know what might be found before doing an audit? Does the Fed release enough information that one can be confident that someone there isn't diverting a few tens of billions of dollars to (a) themselves, (b) their friends, (c) certain politicians, (d) a foreign government, (d) a terrorist organization, or (e) someone else?

I don't know the answer to this question. I would have thought it was audited somehow, but maybe not...

cputter writes:

Why do people so easily equate independence with secrecy? The only argument I hear against the audit is that if the Fed were working in the open it would not be independent for some reason. One would still need to pass some more legislation before congress can influence Fed policy.

Of course the idea that the Fed is independent now is rather ridiculous in itself. Haven't they been colluding with the treasury? With the president? If you look at Volcker ending the high inflation in the 70's he could have only done that with support from the president.


And the Fed keeping inflation low is another joke. The dollar's worth 4% of what it was when the Fed was founded in 1913.

An audit would be a good start to ending the Fed monopoly and allowing for competing currencies.

@Lance Cahill:

These are exactly the things Ron Paul wants to audit:

(1) transactions for or with a foreign central bank, government of a foreign country, or nonprivate international financing organization;
(2) deliberations, decisions, or actions on monetary policy matters, including discount window operations, reserves of member banks, securities credit, interest on deposits, and open market operations;
(3) transactions made under the direction of the Federal Open Market Committee; or
(4) a part of a discussion or communication among or between members of the Board of Governors and officers and employees of the Federal Reserve System related to clauses (1)–(3) of this subsection."


Why on earth should this be kept secret?

Lance Cahill writes:

cputter,

The GAO does currently have the power to audit the Federal Reserve (with written approval by the Fed). The current dispute is a matter of scope--how broad and intensive may an audit be, and what may or may not be included in a report. Can the GAO talk about whether Fed policy has been too tight or too loose in recent times?

The Fed provides, like any other firm, consolidated financial statements. And like other firms, they do not reveal who has received assistance, in order to not undercut the effectiveness of their quantitative programs. It seems to me that most people proposing this bill oppose the Fed's current approach, and they wish to achieve by subterfuge what they cannot achieve by a frontal assault.

Congress can already subpoena (4), and they have (especially with the Ken Lewis hoopla).

It's not a matter of whether Congress should have access to these records, but it is a matter of discretionary authority. Should the GAO have the discretionary authority to essentially operate as a shadow FOMC, with the legitimacy granted as a government organization?

The same reasons the GAO should not have ultimate authority to demand deliberations is the same reason why Oval Office discussions should have some degree of secrecy: Frank and open discussions are vital if policy is not going to be path-dependent and therefore not as relevant to current situations.

cputter writes:

@Lance Cahill,

"It's not a matter of whether Congress should have access to these records, but it is a matter of discretionary authority."

That seems to be a misstatement of HR1207 which merely repeals the restrictions placed on the GAO to have access to those exact records. Congress certainly does not have access to those records at the moment.

From what I gather your argument is that it is better to keep the skeletons hidden in the closet.

Also the Fed is not just any other firm. They've been granted a monopoly on the creation of money. An activity with more destructive power any military force. History clearly attests to that.

It's rather strange to compare Oval Office discussions with Fed deliberations. The last time I checked the president can't sign treaties with foreign governments in secret. He can't give aid to other parties in secret. Nor can he wage wars in secret. At least not lawfully, of course presidents have ignored such quaint concepts as law and the constitution for several decades now.

Whereas the Fed can not only keep their deliberations secret but also their actions and interactions with both foreign and national entities.

One can make the case that if Oval Office discussions were less secret we would not be facing the current mess in Iraq and Afghanistan. Not to mention dozens of other ill-fated wars.

Arguing that people should be kept in the dark regarding the activities of public institutions is rather Orwellian in nature. And hopefully not a winning argument in a free society.

Of course once those records become public knowledge they might be very controversial, or not at all. We simply don't know. Though if it is shown that the Fed has been putting trillions of tax payer money at risk I'm quite sure congress might take issue with that. What they should do then is a totally different debate.

D Reeves writes:

"Also the Fed is not just any other firm. They've been granted a monopoly on the creation of money. An activity with more destructive power any military force. History clearly attests to that."

Ah, more Austrian one-liners. Now, for the truth: history, and that Summers study, can attest to that less central bank independence is a bad bad idea.

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