what’s wrong with having Congress audit the Fed?

I was driving in southern New Jersey yesterday, where car radio reception is spotty.  So I ended up, as usual, listening to Bloomberg Radio on Sirius.  So I heard a lot of Janet Yellen’s testimony before Congress.

Ms. Yellen has a terrible speaking voice.

It’s hard for me to judge how much of the apparent lack of basic economic/financial knowledge evinced by members of the House Committee on Financial Services was real, and how much was political theater aimed at advancing political agendas.  Michael McKee, who formerly covered Congress and who I think is one of the brightest spots on Bloomberg Radio, believes the former.

Anyway, to auditing the Fed.

Let’s be clear.  This isn’t about auditing in the sense of making sure the financial statements are pertinent and accurate.  Nor is it about making sure that every expenditure is documented and every penny accounted for.

It’s about a Rand Paul proposal to give the Government Accountability Office, an arm of Congress, the ability to publicly second-guess the decisions of the Fed on monetary policy.  GAO activity would presumably include not only public criticism of the soundness of policy itself, but also questioning of the Fed policymakers’ opinions and their professional qualifications.  This would be the first step in restricting the independence of the Fed and making it subject to the will of Congress.

What’s wrong with that?

Two things:

–if members of the Fed become targets of public Congressional pillorying, then the list of highly qualified economists lining up to make careers in public service at the Fed will shrink to nothing.  We could end up with unlicensed people driving the school bus.

–the Federal government has currently borrowed $17 trillion+, at relatively low rates of interest.

The primary concern of lenders to the US is that they will be paid back in full.  One of the primary criteria they consider is whether a given sovereign borrower has a monetary authority run by highly skilled economists, free of political influence.  They know that politicians are often short-sighted and in tough times may try to wangle out of their repayment obligations. ( The standard way of doing this is by running an over-loose policy that creates  inflation, reducing the real value of what they owe.)  A strong, independent central bank is lenders’ assurance that this won’t happen.

Implementing the Rand proposal calls this into question.  The response by lenders would be to demand higher interest rates in compensation for the additional risk.  If we assume this would raise the interest rate the government would pay by 50 basis points (I’m making this figure up, but it seems like a good guess to me), that would mean an extra $85 billion a year in interest expense.  This wouldn’t happen right away, and the rise would predominantly be on the longer end of the yield curve, but still…

The US$ is the world’s reserve currency.  This gets us lower borrowing costs and easier access to funds since we’re the bank.  The rest of the world isn’t thrilled by this, but willing to put up with the current system.  That’s in large measure because of the independence of the Fed.  Lose that and creating a replacement (the renminbi?) becomes an urgent concern for the rest of the world.  Again, higher borrowing costs for the US–not right away, but suddenly the possibility has to be on investors’ radar screens.

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