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Centennial tune-up

16 Dec 2013 By Martin Hutchinson, Richard Beales


A U.S. federal commission led to the creation of the Federal Reserve in 1913. Its structure and mandate have evolved, and since 2008 novel activities have enlarged the central bank’s balance sheet to $4 trillion. A centennial commission, as proposed by a Republican congressman, would serve to renew the Fed’s legitimacy.

The Fed’s mandate has changed from the gold standard context in which it was created, in particular with the passing in 1977 of reforms that formalized today’s dual aims of low inflation and full employment. This is one area where a thorough, credible and bipartisan review of the past century could prove valuable.

Recent experience suggests monetary policy can only affect employment indirectly, while attempts at stimulus have the unattractive side-effect of fueling asset price bubbles. This and other contradictions might lead a new commission to propose different goals for the Fed. Alternatives include simple inflation targeting – whether at the Fed’s preferred level of 2 percent or even at zero – or setting a target for nominal U.S. GDP.

The Fed’s structure, with governors comprising a mix of regional bank representatives and presidential nominees, is also unique compared to other central banks. It’s possible a review could result in the idea of making all of them White House nominees, arguably increasing the central bank’s political legitimacy and preserving its governors’ independence of action, once confirmed by the Senate.

Even if the current format were to be retained by the commission, there are good arguments for allowing all 12 regional Fed presidents to vote on monetary policy decisions. Currently, several are non-voting at any one time, on a rotating basis.

As for recent policies adopted by Ben Bernanke’s Fed, like broadening its already unorthodox asset purchases to include long-term Treasuries and mortgage-backed bonds, the commission would need to evaluate interest rate and credit risks and perhaps set limits on the Fed’s exposure, as well as on the size of its balance sheet – either in absolute terms or in relation to U.S. GDP.

Bernanke himself has said that central banks have to adapt and, in remarks on Monday at a centenary event in Washington, he also talked about the need for clarity, transparency and accountability. The Fed is a hugely different organization from the modest panic-prevention institution established in 1913. With 100 years under its belt and five years of post-crisis activity to examine, a new commission could be just what’s needed.


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