A Wacky Attack on the Federal Reserve Transparency Act at Thoughts on Liberty

Over at Thoughts on Liberty, Brittney Wheeler has made some poorly founded claims about Federal Reserve policy and oversight. Usually when I read some bit of foolishness promoted by the ToL crowd regarding liberty, I ignore it because they are arguing about social issues. This recent bit is too much for me sit back and let the authors at ToL continue to spout their ignorance. In this case, Brittney Wheeler needs to spend more time reading about the Federal Reserve, public choice economics, and monetary policy in order to formulate a useful opinion about the Fed. I find the lack of expertise and standards at ToL appalling, given that they are writing for such a broad audience. As usual, the author is bordering on charlatanism in this recent post.

Wheeler has chosen a poor time to defend a lack of transparency at the Fed. Recently, Carmen Segarra exposed officials at the Fed for specially favoring Goldman Sachs. According to USA Today,

In one session on tape, as the examining team was discussing tactics for probing a Goldman deal one of them characterized as "legal but shady," this timidity was on full display.

"I think we don't want to discourage Goldman from disclosing these types of things in the future," said one male participant who remained unidentified in the transcript, "and therefore maybe you know some comment that says don't mistake our inquisitiveness, and our desire to understand more about the marketplace in general, as a criticism of you as a firm necessarily. Like I don't want to, I don't want to hit them on the bat with the head [sic], and they say screw it, we're not gonna disclose it again, we don't need to."

Officials at the Fed were concerned with not offending a bank that they were bailing out. Think about the insanity of this. A large financial firm acts irresponsibly in the market. Not only did the U.S. government socialize the losses, they did not want to offend those responsible for this disaster. Instead of ensuring discipline within the market, they give a poorly behaved firm special treatment! When the Federal Reserve severs the decisions of a firm from the profits and losses that result from those decisions, they destroy market discipline and deal harm to the process by which markets provide information of scarcity and wants to consumers and producers. It is clear that officials are in no position to regulate the financial industry. Wheeler fails to consider this recent fiasco in her post.

Perhaps Miss Wheeler is living under a rock. This would explain why she ignores the recent revelation and argues for maintenance of Fed independence.

Why is the independence of the Federal Reserve important? Why shouldn’t Congress have a hand in monetary policy actions? The Fed was specifically designed to maintain as much independence from the political process as possible… and with good reason! Effective monetary policy must be concerned with long-run goals, not short-term political gain.Although the Fed ultimately does answer to Congress and the people in terms of its mandated goals, there is a difference between being accountable for achieving goals and actually allowing Congress to insert itself into the monetary policy making process.

But what is effective monetary policy? This is where Wheeler finds herself in the mud because she does not understand the topic about which she writes. Her statement also implies that she does not consider, or perhaps, lacks the facility to consider the dynamics and effects of political decision making.

Whether or not the Federal Reserve is independent, policy is decided on a political basis. In one case, firms receive special privileges according to the dictate of Fed officials. In the other case, those in the legislative branch sway policy in favor of interest groups. Of course, reality is a mixture of these cases, probably weighted more toward the first than the second at present. While the second case may be worse than the first – it is difficult to say for sure – robust political economy tells us that the actions of Fed officials today are not appropriately constrained so as to prevent both and provide an outcome better than the one that would likely result in the market. I expect that transparency will be a relatively effective constraint given a robust rules framework.

The appropriate policy decision, then, does not choose only between oversight or no oversight. Oversight is of little help without a robust framework to guide policy. Federal Reserve policy must be guided strictly by a well-defined and well-implemented rule in order to prevent the influence of special interests over monetary policy. Wheeler would be better off arguing that the Fed should be audited, but that any legislation that promotes an audit should also include a provision for a monetary rule. This would neuter the ability of Fed officials to grant special favors to firms and to politicians. And, in line with Hayek’s thesis in The Constitution of Liberty, this type of regime would make the consequences of one’s actions more predictable. As he writes early in the book,

This is possible only by the state’s protecting known private spheres of the individuals against interference by others and delimiting these private spheres, not by specific assignation, but by creating conditions under which the individual can determine his own sphere by relying on rules which tell him what the government will do in different types of situations.

If they want to do the world a favor, the authors at ToL should first read the thoughts of their forbearers and understand the deeper substance of the political debates in which they engage. (Wheeler did at least read one academic paper in building her argument.)  At the core of an argument for limited political intervention is a desire for good rules that constrain the behavior of agents both in the private and public spheres. Those rules require transparency in order to be effective. If independence is sacrificed by transparency as a consequence of the Federal Reserve Transparency Act, the independence lost is the sort of independence that allows Fed officials to treat banks like Goldman Sachs as above reproach. This is a type of independence that is not subject to rules. Instrument independence, the type on which Miss Wheeler focuses her post, can be facilitated by the inclusion of George Selgin's five suggestions to guide the form of Fed operations: “(1) abolish the primary dealer system, (2) limit or abolish repos, (3) abandon “Treasuries only,” (4) revive the Term Auction Facility, and (5) stop last-resort discount window lending (312).”

The text I cite from ToL contains an additional problem. Wheeler fails to defend her claim that independence is necessary and sufficient for the Fed to be effective. She needs to consider whether the Fed was effective at all. Instead, she buys into the typical rationale for a central bank,

The Federal Reserve System was created in 1913 with the goal of providing a more stable and flexible monetary and financial system at a time when banking panics were a common occurrence and caused a lot of economic distress.

Really? According to Selgin, Lastrapes, and White, the Fed has caused more volatility than it has helped prevent. Anyone who reads this blog knows that Fed officials engaged in disastrous policies alongside the insane Bank of France during the Great Depression. Even when we remove these years from the record, Selgin, Lastrapes, and White show that the Fed regime has performed about as well as pre-Fed arrangements. The pre-Roosevelt Fed was had a high degree of independence, but this did not stop the implementation of destructive policies that ushered in the Great Depression. I hope that Miss Wheeler can see how the stated purpose of the Federal Reserve differs from its actual consequences. Let's not be given to the nirvana fallacy. Miss Wheeler would also benefit from reading Timberlake to understand the central bank role of clearinghouse associations before the establishment of the Fed.

Finally, Wheeler fails to show the reader what effective monetary policy looks like. As I have shown in the final section of “Whither Gold?”, good policy is both predictable and makes the monetary base respond to changes in demand for base money. As long as we the Fed exists, its actions should be limited to facilitating changes in demand for base money and thus provide a nominal anchor much like the gold standard provided. For this rule to be executed successfully requires increased transparency at the Fed. In other words, we cannot be sure monetary policy is effective unless we know the rationale behind the implementation of those policies. In the case of a nominal income level target, the rationale comes from Say’s identity and the equation of exchange. If implemented as a policy rule within the framework of the Federal Reserve Transperency Act environment, there is a much greater probability that the rule will be implemented properly.

Summing up, implementation of a good rule is not possible without transparency - the type which the Federal Reserve Transparency Act promotes. Given the special treatment of Goldman Sachs in the recent crisis, it is critical that we implement both a good policy rule and framework for transparency. These cannot be treated separately. Wheeler should not be arguing that the Federal Reserve Transparency Act is going to hurt the efficacy of monetary policy. She should argue that transparency must include a rule so that market actors can form more accurate expectations.