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From Banking and Finance Law Daily, December 13, 2013

Financial Services Committee hearing examines Fed’s mandates

By J. Preston Carter, J.D., LL.M.

In opening remarks at the House Financial Services Committee Hearing entitled “Rethinking the Federal Reserve’s Many Mandates on Its 100-Year Anniversary,” Chairman Jeb Hensarling (R-Texas) said the committee “will undertake the most rigorous examination of the Federal Reserve Board’s purposes, policies and track record in its history.” He stated that this “first hearing will consider many mandates of the Federal Reserve, including classic monetary policy, prudential regulatory policy, full employment, systemic risk regulator, lender of last resort, and effective financier of our unsustainable debt. We will also consider the Fed’s role in credit allocation, arguably picking winners and losers, particularly the burdens this has placed—low interest rates have placed on fixed-income seniors.”

A Committee Majority Staff memorandum stated that the hearing will provide an opportunity for witnesses to examine the many mandates under which the Fed operates and explore whether those mandates are appropriate for a central banking system.

Fed success. Rep. Maxine Waters (D-Calif), Ranking Member of the Financial Services Committee, underscored the success of the Fed in stabilizing markets and reducing unemployment in the wake of the financial crisis. She also cautioned lawmakers seeking to make legislative changes to the Fed or its mandate that Congress should allow it to finalize the important reforms included in the Dodd-Frank Act that reduce the likelihood of future financial crises.

Alice Rivlin, Senior Fellow, Economic Studies, Brookings Institution, urged “leaving the [Fed’s] multiple mandates as they stand.” According to Rivlin, the job of the Fed and other economic policy-makers is to balance the multiple objectives of high employment, low inflation, and financial stability. She said the recent accommodative policy could be “defended as needed to avoid the risk of deflation, even without mention of employment. In view of recent history, telling the central bank that it need not worry about the stability of the financial sector is too ridiculous to deserve discussion.”

Changes sought. Dr. Marvin Goodfriend, friends of Allan Meltzer, Professor of Economics, Tepper School of Business, Carnegie-Mellon University, and Research Associate at the National Bureau of Economic Research emphasized six points in his testimony:

  1. Fed credit policy (financed with monetary policy) worked well to stabilize short-term credit markets after the full-blown financial crisis erupted in fall and winter 2008-2009.
  2. However, the ambiguous boundary of expansive Fed credit policy itself triggered the crisis on Sept. 16, 2008, when the $85 billion Fed loan to American International Group drew criticism from prominent members of Congress as a questionable commitment of taxpayer funds.
  3. The public became frightened that neither the Fed nor Congress would offer further effective support for the financial system.
  4. The personal saving rate rose sharply by 5 percent, collapsed spending, pushed unemployment to 10 percent, and the mild contraction that began in December 2007, became the Great Recession.
  5. The enormous growth of shadow banking that financed the unstable credit cycle was facilitated, in the first place, by ineffective regulation of banking and money market finance divided between the Fed and the Securities and Exchange Commission.
  6. To better serve the Fed’s employment and financial stability mandates, the boundary of the Fed’s credit policy reach should be narrowed and clarified, and the Fed should be given authority to make sure that money market rules and regulations preserve monetary stability.

In his remarks, Dr. Douglas Holtz-Eakin, President, American Action Forum, emphasized:

  • the fundamentals of financial economics dictate multiple roles for a policy body such as the Fed;

  • corresponding to these policy imperatives are explicit or implicit mandates for the Fed; and

  • the exercise of multiple mandates may raise the possibility of diminished performance on any single mandate, such as macroprudential regulation, and leave behind legacy costs like the Fed’s expanded balance sheet.

Volcker Rule. Hester Peirce, Senior Research Fellow, Mercatus Center, George Mason University, faulted the Fed for its “failure to use economic analysis in crafting the Volcker Rule.” He continued that the Fed “has showed a persistent reluctance to embrace economic analysis, even though it is a useful tool for identifying the problems the Board is trying to solve, the range of possible solutions, and the costs and benefits of those different options.”

MainStory: TopStory FederalReserveSystem FinancialStability

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