Who is the boss when it comes to Federal Reserve and Congress?

Published in The Hill.

In January 2008, Federal Reserve Chairman Ben Bernanke made this memorable announcement: “The Federal Reserve is not currently forecasting a recession.” This was a poor forecast indeed, since as we now know, a very deep and painful recession had already started by the time of this prediction that there would not be one.

But this is only one of many such errors. If you have the unrealistic belief that the Fed should somehow manage the economy, banking system, stock market, financial stability, interest rates, employment, inflation and risks, you run into a granite wall of a knowledge problem. The Fed does not know and cannot know enough to do all this.

The simple fact is that the economic and financial future of this great nation is not only unknown, but unknowable, for the Fed as it is for everybody else. It is not that our central bank is any worse than anybody else at knowing the future, including what the results of its own actions will be, but the Fed is just not any better than anybody else.

Yet, the Fed keeps insisting and has enshrined as part of its own confession of faith that it ought to be “independent” as an immensely powerful fiefdom answerable only to its own theories. Should the Fed be independent of Congress? Given the inherent human will to power, naturally those leading the central bank would like to be.

This desire to act as independent economic philosopher kings could be justified by a claim to superior knowledge. But the Fed demonstrably does not have such superior knowledge. Still, we cannot avoid observing that there is a strange and quite common faith in the Fed. For example, it is endlessly repeated in the media that an inflation rate of 2 percent a year must be good because that is the Fed target, apparently without wondering whether this target is a good idea or not.

Of course, some people have more skeptically considered the 2 percent question. Olivier Blanchard, formerly the chief economist of the International Monetary Fund, has stated, “There is no sound economic research that shows 2 percent to be the economically optimal inflation rate.” He was arguing for higher inflation. On the other hand, Alan Greenspan, when asked what the right inflation target was, said “zero” and added “if measured correctly,” a wonderfully famous hedge.

A remarkable thing about the current idea of a Fed inflation target is that it is a target in perpetuity at 2 percent a year forever. To commit for 2 percent a year forever means that in an expected lifetime of 82 years, average prices will quintuple. With a straight face, the Fed informs us that this is “price stability.” Should Congress have anything to say about whether it wants inflation of 2 percent a year forever?

The Fed often states that “price stability” is part of its statutory “dual mandate.” The reference is to the Federal Reserve Reform Act of 1977. But this law does not say “price stability.” It says “stable prices.” It does in particular not say a “stable rate of inflation.” It says “stable prices.” Does the term “stable prices” mean perpetual inflation? What did Congress mean by “stable prices” when it put that term into law?

We learn from the minutes of the Federal Open Market Committee that in 1996, when the Fed was discussing whether it should have an inflation target, one member of the committee dared to ask what Congress meant by the statutory language. This question was quickly passed over and not pursued. But it was a good question, was it not?

In fact, we have a good indication of what Congress meant by “stable prices.” The very next year, in the Humphrey Hawkins Act of 1978, Congress provided the “goal of achieving by 1988 a rate of inflation of zero.” Obviously, this was not achieved and somehow, we never hear the Fed discussing this goal as expressed in statute.

Bernanke advised Janet Yellen, his successor as head of the central bank, to remember that “Congress is our boss.” But does the Fed and those who work there really believe that Congress should be the boss? That these mere politicians, elected by the American people, should be in charge of the powerful economic and financial experts of the Fed?

William Proxmire, a former senator from Wisconsin, once put the case for Congress pretty bluntly in a hearing. He stated, “You recognize, I take it, that the Federal Reserve Board is a creature of Congress?” and “Congress can create it, abolish it, and so forth?” While that is certainly true, but short of abolishing it, what steps can be taken for greater accountability and more effective legislative governance of the Fed?

It seems the best model might be to think of Congress as the board of directors and Federal Reserve officers as the management of government operations in money. With this model in mind, the relationship of the Fed and Congress should evolve into a grown up and real discussion of issues, alternatives, strategies and risks. That would be quite a contrast to the media event that Fed testimony now represents.

Such discussions might even include the Fed asking Congress what it means by “stable prices” as a goal. Of course, the Fed could lay out all its arguments for 2 percent inflation and its thoughts on alternatives for legislative consideration. Can you imagine that? Perhaps you cannot, but as the long history of the Fed demonstrates, many things that were previously unimaginable nevertheless came to pass.