FRB Chair Yellen Criticizes Fed Oversight Reform and Modernization Act
Commentary by Steven Lofchie
Board of Governors of the Federal Reserve System ("FRB") Chair Janet Yellen expressed strong opposition to proposed legislation that would (i) generally require the FRB to follow a mathematical formula in its monetary policy and (ii) provide Congress with much more direct authority over the conduct of the FRB. In a letter addressed to House Majority Leader Paul Ryan and House Minority Leader Nancy Pelosi, Chair Yellen asserted that Congressional control over monetary policy, or the requirement that monetary policy follow a formula, would result in higher unemployment, less stable prices and, ultimately, material damage to the U.S. economy. She asserted that if the FRB were required to follow such a prescribed mathematical formula in the implementation of monetary policy, then unemployment would be materially higher and inflation would be too low. FRB Chair Yellen also criticized the restrictions that the proposed legislation would put on the FRB's authority to lend money to financial institutions in the event of a liquidity crisis.
Commentary
Ever since the financial crisis, the FRB has exercised far greater regulatory power than it did previously and, arguably, has done so without close Congressional supervision. Whether it has exercised this power well in the past, and whether it should continue to exercise this power only under light supervision, are two legitimate historical and political questions. Assertions about hypothetical rate policy, however, are fundamentally unprovable. How can the FRB demonstrate that the subjective rate policy that it followed produced a better economic result than the formulaic policy that it did not follow? Ultimately, the basis of Chair Yellen's certainty on rate policy cannot be demonstrated empirically. As to whether the FRB should retain the power to provide liquidity to financial institutions in a time of general market crisis, powerful arguments can be made for that power based on observations and conclusions drawn from the last financial crisis: once the panic set in, there was no liquidity in the markets. Had the FRB not stepped in, all of the money market funds would have failed, and depositors would have pulled their money (to the extent that they were able) out of the banks. Then the banks would have failed, and the smaller/slower depositors would have lost everything. That is what happens in a liquidity crisis.