“Audit the Fed” is Just a Nicer Way to Say “Put Congress in Charge of the Fed”

by pdxblake

Ok, so any claim Romney might have to understanding economics based on his “business experience” (which I rated as dubious at best) is now gone (ht Business Insider):

“The answer is yes to that, very plain and simple,” Romney responded, when asked by a supporter at a New Hampshire town hall whether it was time to audit the Fed. “The Federal Reserve should be accountable. We should see what they’re doing.

The Fed is audited already.  The idiotic idea of ‘auditing the Fed’ made prominent by Ron Paul is not a conventional audit, it is a way to incorporate politics into Central Banking by allowing politicians to second-guess Fed decisionmaking.  (I addressed many of the issues that people don’t understand about how the Fed works in two other posts, part 1 and part 2).  As for whether the Fed is audited, they have a quite comprehensive list of oversight over the institution, which I will copy and paste at the bottom of the post because, really, how many people are going to click through to the Fed’s website?

One of the important issue of monetary policy particularly now in dealing with economic changes is that it can respond both quickly and in a way that has a relatively fast impact on the economy.  The need for speed was on display during the financial crisis when the Fed stepped in to stop a collapse in the financial system, while the other economic level, Congress, dithered about approving the TARP even as financial markets swooned, falling 777 points in a day.

Proposals to ‘audit’ the Fed would strip the Fed’s effectiveness because, even if it moves quickly, its moves could be subsequently reversed under political pressure, which strips the credibility from Fed moves (because the stock and bond markets react to the Fed’s moves as if they were inevitably going to be carried out).

Outside of crisis situations, there are other reasons for central bank independence.  Mostly that more independent central banks are associated with lower long-term inflation rates.

HT Mark Thoma, graph from “Central Bank Independence and Macroeconomic Performance: Some Comparative Evidence,” by Alberto Alesina and Lawrence H. Summers, Journal of Money, Credit and Banking, Vol. 25, No. 2. (May, 1993), pp. 151-162

The theoretical explanation for this relationship at its simplest is that there is a benefit for each government to boost the economy before elections without recognizing fully the costs of the resulting rise in the price level (since it will tend to happen regardless of the state of the economy and whether or not it needs the stimulus).  This leads to a political business cycle of higher growth in the year before elections followed by a slowdown and then another boost near the next election.

The problem comes because the stimulative effect comes quickly, while the higher inflation (when the stimulus is pushed into an economy operating near its full capacity) comes later (after the election).  The higher inflation from each successive cycle of electioneering monetary stimulus is often not enough on its own to raise fears of higher inflation, but each successive cycle increases the inflation rate.  As a result, most countries have moved towards more central bank independence.

The idea of ‘auditing the Fed’ proposed by Ron Paul, and now Mitt Romney, would move in the opposite direction towards greater politicization of monetary policy which would harm its ability to fight crisis and, perversely for Romney and Paul’s stated goals, would likely lead to higher inflation rate.  It is an innocuous sounding way to propose a quite radical policy.


Does the Federal Reserve ever get audited?

Yes, the Board of Governors, the 12 Federal Reserve Banks, and the Federal Reserve System as a whole are all subject to several levels of audit and review:

In addition, the Reserve Banks are subject to annual examination by the Board. The Board’s financial statements and the combined financial statements for the Reserve Banks are published in the Board’s Annual Report.

See our audit page for more information on all of the above audits and more information on the accounting, financial reporting, and internal controls of the Federal Reserve Board and Federal Reserve Banks.