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Markets around the world were relieved by the US Senate's
confirmation of Federal Reserve Board Chairman Ben
Bernanke's reappointment. It was the right decision
from the perspective of financial stability; change
at the top would have thrown in doubt the Fed's
determination to respond decisively to the crisis -
and, indeed, its long-term commitment to low
inflation.
Bernanke's performance over the last two years has won high
praise, and an extended political fight over control
of US monetary policy was the last thing the world
needed at what is still a very delicate moment for
the global economy.
Nevertheless, 30 senators voted against Bernanke. This may,
in part, have just been partisan politics, but
Bernanke was appointed by President George W. Bush,
and there were other voices, both Democrat and
independent, raised against his reappointment.
The case against Bernanke rested partly on his performance
before the crisis. Was he not a hard-core member of
the "Greenspan consensus," which held that it was
not the Fed's responsibility to look out for
bubbles, whether of asset prices or credit, and that
it should limit itself to mopping up after the
event?
Bernanke had also supported the low-interest-rate policy
implemented after the dot-com collapse,
which, in the view of many economists, was
maintained for too long, fueling the boom and
contributing to the bust. Indeed, just recently he
defended that policy, whereas many other central
bankers have tacitly or explicitly accepted that
they need a new approach to credit and asset prices.
That was, I think, part of the reason for many
commentators' doubts about Bernanke's continued
suitability. But these arguments became tangled up
in a broader critique of the Fed's actions.
Should it have been allowed to rescue the insurance giant
AIG so expensively, without approval by the US
Congress? How is it that the Fed's balance sheet can
expand so dramatically, potentially committing large
sums of taxpayer dollars, without Congress having a
purchase on its decisions, except well after the
event?
These questions have led to pressure for audits of the
Fed's actions, and for greater political control
over its decision-making. Congressman Ron Paul has
been leading the pack hunt on the Fed, but he is by
no means as isolated a voice as he was two years
ago.
This is dangerous territory. Any suggestion that
monetary-policy decisions would in future be subject
to political override would, to use a non-technical
term, spook the markets. Most developed countries
have concluded that central-bank independence makes
good sense. Politicians acknowledge, in their more
rational moments (yes, they have them), that they
cannot be trusted with the interest-rate weapon,
especially as elections approach. So they have
handed it over to technocrats, in the hope that they
make rational choices that benefit everyone.
I share this consensus view. But there is a problem, and
the crisis has highlighted it. The arguments that
apply strongly in the case of interest rates are
less clear when it comes to other functions that
central banks may carry.
If a central bank is committing public funds in support of
individual firms, even with a systemic
justification, do not different accountability
considerations apply? And if it is a direct
institutional supervisor, as well as being the
lender of last resort, there are different
considerations again. Supervisors make decisions
that, in effect, have an impact on private financial
returns and property rights. They must operate
within tight legal constraints, and with rigorous
accountability frameworks, involving the government
and the legislature.
In its proposed reforms of the regulatory system, the Obama
administration plans to give the Fed more of these
powers. That has inevitably strengthened the hands
of those who argue that more power requires more
accountability.
The problem is how to establish two different types of
accountability for two different functions. Is it
possible to maintain a rigorously independent
chairman when it comes to interest rates, and a
tightly accountable chairman when he is making
supervisory decisions? Only with great difficulty,
is my answer. It is very hard to make legislators
understand these delicate distinctions. There is
bound to be some contagion from one function to
another.
So the proposals to strengthen the Fed's regulatory role
carry great risks. It would be far better, in my
view, to leave the Fed with an overall systemic
role, which raises fewer new accountability issues.
Below it, there is the opportunity to create a
single banking supervisor, combining the functions
of the Office of the Comptroller of the Currency,
the Office of Thrift Supervision, and the regulatory
functions of the regional Feds. In a perfect world,
one would add in the state banking regulators, but I
recognise that at this point I have begun to trample
on cherished features of the US Constitution!
This regulatory architecture would leave the Fed free to
speak openly about the development of the financial
system as a whole, without worrying about the
implications for individual institutions in its
care. The crisis has demonstrated that we need this
plain speaking. Moreover, such a solution would
protect the Fed's crucial independence in its
monetary-policy role.
President Obama should not draw the conclusion that
arguments about the Fed's accountability have gone
away with Bernanke's confirmation. If he proceeds
with plans to give it more functions, they will
persist. To protect the Fed's independence, which is
a global public good of the highest importance, he
should cut back the Fed's authority to its core
role.
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