Time To Rein in a Runaway Federal Reserve That Took Congress for Granted

Published in the New York Sun and the Federalist Society.

Juvenal put it best when he asked, who will guard the guardians.

The ancient Roman poet, Juvenal, posed the incisive question that must be applied to all structures of power and authority, “Sed quis custodiet ipsos custodes?” Who will guard the guardians? Let us apply Juvenal’s question to the Federal Reserve.

The Federal Reserve endlessly repeats that it ought to be “independent.” If it is independent, though, who will guard our central bank? The Constitution grants that power — to “coin Money, and regulate the Value thereof, and of foreign coin” — to the Congress.

Every economist with whom I have ever discussed this question immediately replies, “You certainly don’t want a bunch of politicians managing monetary policy.” They all assume that elected politicians will always impose an inflationary bias which the expert central bank will resist.

Yet it was the Fed, without congressional approval, that unilaterally announced in 2012 that it was committing the nation to inflation and perpetual depreciation of its currency at the rate of 2 percent a year. That means average prices quintuple in a lifetime — an odd interpretation of the Fed’s statutory mandate of “stable prices.”

Would Congress have approved a commitment to 2 percent inflation forever? The Fed didn’t seek or wait for an approval from Congress. “The Congress let us put in an inflation target without being part of the process,” Mr. Bernanke, I was reminded by the Sun, boasted to a recent panel.

In internal Fed discussions when Alan Greenspan was chairman, he suggested that the right inflation target was “zero, properly measured” and that the setting of an inflation target should involve the Congress. The Bernanke Federal Reserve adopted neither suggestion.

Moreover, the Fed unilaterally increased its inflationary tilt in 2020 by announcing, again without the approval of Congress, that the 2 percent target meant on average over some unspecified time, so that it might run higher when the Fed desired.

In contrast, other countries — notably the first country with a formal inflation target, New Zealand — set that target of zero to 2 percent as an agreement between the parliamentary government and the central bank.

Why does the Fed need a guardian? Its formidable power combined with the inherent unknowability of the economic future makes it a most dangerous source of systemic risk, and it experiences the constant temptation to be the captive finance company of the Treasury.

A way to improve the substantive oversight of the Congress would be for the Senate Banking Committee and the House Financial Services Committee to each form a new subcommittee devoted solely to engaging the key issues of the Federal Reserve.

The central bank is important enough to the country and the world, and powerful enough for good or bad, to merit this accountability. How much the mandarins of the Fed would hate this idea is a good measure of how important it is.

Such subcommittees would not be impressed by the “pretense of knowledge,” in F.A. Hayek’s particularly perceptive and piercing phrase. Nowhere is this pretense so common as in the Federal Reserve and central banks in general.

These subcommittees would be studying and quizzing the Fed about its recently released first quarter financial statements. They would be probing its knowledge and skill, and examining its booking massive net losses. They would examine how the Fed has itself become technically insolvent.

These are the results of its truly remarkable $5 trillion mismatch of long term, fixed rate assets, including $2.6 trillion of mortgage securities, funded by floating rate liabilities. This has become an expensive mismatch indeed.

In the first quarter alone, the Fed suffered a net loss of $27.7 billion. That annualizes to a net loss for the year of about $110 billion — a number big enough to get anyone’s attention. When the Fed is making money, its profits go to reduce the federal deficit; when it loses money, the government’s deficit is increased.

Did the Fed discuss with the Congress how the interest rate risk it took was going to cost the government $110 billion this year? And how much in the coming years? What could be done? Should the Fed’s dividends to its shareholders be cut? Should its paying the expenses of the unrelated Consumer Financial Protection Bureau be scrapped?

The Federal Reserve has lost billions every month since October 2022, up to an aggregate net loss of $70 billion so far. This far exceeds its total capital of $42 billion, so the Fed’s actual capital is now negative $28 billion and constantly getting more negative. The Fed insists that its negative capital doesn’t matter, but would Congress agree? Might Congress prefer the greatest central bank in the world to have positive capital?

Finally, it is certainly time to reconsider the question of committing the nation to inflation forever at 2 percent, with the engagement and required approval of the Congress. The Money Question — in Latin or plain English — is far too important to be left to unguarded central bank guardians.