THE FEDERAL RESERVE significantly has altered the procedures and goals that it had followed for decades. It has more than doubled its balance sheet, paid interest to banks on reserves held as deposits with the Fed, made decisions about which institutions to prop up and which should be allowed to fail, invested in assets that expose taxpayers to large losses, and raised questions about how it will avoid inflation despite an unprecedented increase in the monetary base. We should document why the Fed took each step, what the expected results were, and whether those results were achieved. However, not many congressional colleagues support the bill of Rep. Ron Paul (R.-Tex.) calling for an audit of the Fed. Remarkably, there is significant opposition to such oversight, and the political prospects for undertaking such an audit are relatively bleak.
Although audit opponents express concern over keeping the monetary authority insulated from political pressure to inflate, one could argue that the larger threat to Fed independence comes via its departure from standard operating procedures. How did Fed officials undertake determining whether this primarily was a liquidity or primary crisis? The profit or loss of the Fed's investments would provide a very helpful indicator of whether the Fed's actions served the economy as a whole or merely transferred wealth from ordinary taxpayers to bank shareholders.
In congressional testimony on July 21,2009, Federal Reserve Board Chairman Ben Bernanke stated: "The Congress has recently discussed proposals to expand the audit authority of the GAO [Government Accountability Office] over the Federal Reserve. As you know, the Federal Reserve is already subject to frequent reviews by the GAO. The GAO has broad authority to audit our operations and functions. The Congress recently granted the GAO new authority to conduct audits of the credit facilities extended by the Federal Reserve to 'single and specific' companies under the authority provided by section 13(3) of the Federal Reserve Act, including the loan facilities provided to, or created for, American International Group [AIG] and Bear Steams. The GAO and the Special Inspector General have the right to audit our TALF [Term Asset-Backed Securities Loan Facility] program, which uses funds from the Troubled Assets Relief Program.
"The Congress, however, purposefully--and for good reason--excluded from the scope of potential GAO reviews some highly sensitive areas, notably monetary policy deliberations and operations, including open market and discount window operations. In doing so, it carefully balanced the need for public accountability with the strong public policy benefits that flow from maintaining an appropriate degree of independence for the central bank in the making and execution of monetary policy. Financial markets, in particular, likely would see a grant of review authority in these areas to the GAO as a serious weakening of monetary policy independence." Similarly, a petition signed by a broad spectrum of prestigious economists emphasizes the importance of maintaining the appearance and reality of independence of monetary policy decisions from political pressure. The petition states: "Amidst the debate over systemic regulation, the independence of U.S. monetary policy is at risk. We urge Congress and the Executive Branch to reaffirm their support for and defend the independence of the Federal Reserve System as a foundation of U.S. economic stability. There are three specific risks that must be contained.
"First, central bank independence has been shown to be essential for controlling inflation. Sooner or later, the Fed will have to scale back its current unprecedented monetary accommodation. When the Federal Reserve judges it time to begin tightening monetary conditions, it must be allowed to do so without interference. Second, lender of last resort decisions should not be politicized. …