Why Congressional challenges to the Yellen Fed matter

Fed chair Janet Yellen, heads to the Senate today. Will the glasses be half-empty or half-full? (Jacquelyn Martin/ Associated Press)
Janet Yellen, the chairwoman of the Fed, appears Tuesday morning before the Republican-led Senate Banking Committee to deliver the Fed’s congressionally-mandated, semiannual report on monetary policy.
Republicans have previewed their criticisms of the Fed.  Some urge new audits, others call for a more formulaic policy rule to reduce the Fed’s discretion over interest rates.  Senators from both political parties have questioned the Fed’s regulatory performance, alleging lax supervision of Wall Street institutions by the New York Fed.  Even the president of the Dallas Federal Reserve Bank has counseled reform, suggesting that the Fed’s monetary policy committee be revamped to decentralize power away from Washington and New York and into the hands of the 11 other regional reserve banks (including the Dallas Fed that he currently leads).
Yellen will be in the hot seat to defend the Fed’s performance and to combat proposals that central bankers find ill-advised, such as Sen, Rand Paul’s (R-Ky.) “audit the Fed” bill.  It is tempting to dismiss the audit crowd as truly ill-informed about the Fed and to oppose new audits on the grounds of potentially adverse economic consequences. But by rejecting lawmakers’ proposals, I think the Fed and its defenders risk misjudging the political import of legislators’ demands for greater accountability.
Yellen’s political challenge is four-fold:
First, Paul’s charges about the Fed may be wildly off base.  (Mistakenly, he argues for example that the Fed is more highly leveraged than Lehman Brothers and thus at risk of going bankrupt.) But his proposed solution — lifting a prohibition against Government Accountability Office (GAO) review of Federal Open Market Committee decisions (FOMC) — surely fits along a continuum of decisions that Congress has historically made about Fed independence.  Fed Governor Jay Powell put it best earlier this month, noting that the audit proposal would risk “reversing decades of deliberate efforts by the Congress to insulate the Fed from political pressure in carrying out its day-to-day duties.”  Note Powell’s choice of the words “by the Congress.”  Powell’s framing appropriately places Congress at the heart of decisions about tradeoffs between independence and accountability, making plain that Fed autonomy is ultimately subordinate to legislators’ preferences.  The Fed was not born independent: Congress made it that way in fits and starts over the Fed’s first century.  Many will disagree with Paul’s particular prescriptions for the Fed.  But in a democratic society, decisions about the governance of central banks surely fall to the legislature.
Second, Republicans do not have a monopoly on proposals that would increase political pressures on the Fed’s monetary policy making. During the early 1980s when the Volcker Fed quashed inflation and threw the country into a deep recession, several Democratic lawmakers (including Daniel Patrick Moynihan, John Dingell, and Byron Dorgan) proposed measures that would rein in the Fed’s discretion: they advocated reforms that would require oversight of Fed decisions affecting interest rates, reinstall the Treasury Secretary on the Fed’s Board of Governors, and make the terms of the president and the chair of the Fed coterminous.  The timing of such threats of course was not coincidental: Inflation and sky-high interest rates hurt their constituents, compelling lawmakers to propose greater political oversight of the Fed’s policy choices.  Granted, an analogy between Moynihan and Paul only goes so far.  Still, they shared a common reaction to the Fed: Reduced independence for central bankers might be worth it if it made the Fed more accountable to legislators’ views.  Campaigns to rein in the Fed have a bipartisan history, not surprisingly given the centrality of the Fed’s policy choices to the health of the economy.
Third, lawmakers are especially likely to review tradeoffs between independence and accountability in the wake of financial and economic crises.  As Mark Spindel and I argue here, that tradeoff is most apparent when interest rates hit zero—compelling central banks to break the glass and tap unconventional tools to ease policy further. For example, the Fed’s quantitative easing (QE) was intended to lower long-term borrowing rates by purchasing both Treasuries and GSE-sponsored mortgage debt.  QE supporters argued that because housing finance was at the heart of the financial crisis, it was essential to bolster housing markets by reducing mortgage rates.  Critics, including Jeffrey Lacker (the president of the Federal Reserve Bank of Richmond) countered that QE tilted the playing field, shaping the allocation of credit across different classes of borrowers. Either way, the Fed’s unconventional tools blurred the line between monetary and fiscal policy and put the Fed in the politically fraught position of seeming to choose economic winners and losers.  Today, the Fed’s policies continue to garner lawmakers’ concern as the FOMC debates when and how to lift rates to wind down extraordinary monetary accommodation.
Finally, the confluence of financial crisis and partisan polarization intensifies legislative pressure to limit the Fed’s independence.  Granted, Democrats and Republicans reacted differently to the Fed’s conduct of monetary policy at the zero bound.  For instance, nearly two-dozen Republican economists, money managers and former GOP officials penned an unprecedented letter to Bernanke criticizing the FOMC’s QE plan.  In contrast, Democrats largely supported QE, but many argued that the Fed could do more to address the needs of American workers in the wake of the recession.  Still, despite partisan differences, Congress and the president in enacting Dodd-Frank in 2010 required disclosure of the Fed’s emergency loans, limited the scope of the Fed’s emergency lending power, and curtailed the Fed’s autonomy as lender of last resort.
My sense is that the Fed absorbed the broader lesson of these past congressional threats.  Lawmakers in the wake of the financial crisis made clear to the Fed that its precarious political standing required greater responsiveness to the (often conflicting) demands of its congressional overseers.  Bernanke responded by reaching out to Main Street: he explained and defended monetary policy choices in college lectures, town hall meetings, and nationally televised interviews. Yellen’s trip last year to a Chicago manufacturing plant tied esoteric monetary policy to the economic wellbeing of specific individuals, highlighting how unprecedented monetary policy accommodation shapes the lives of ordinary Americans.
Ultimately, accountability trumps independence when lawmakers are particularly eager to blame the Fed for a crisis.  With disagreements rising about the timing and pace of rate increases and about the size of the Fed’s balance sheet, Yellen and the Fed will continue to face calls for greater responsiveness to Congress.  A key question going forward is how Yellen will respond to this new political gauntlet as she traverses the Hill today and in the months to come.