Congress could limit the Fed’s independence and hurt the US economy – Washington Post

By David A. Singer By David A. Singer February 13 at 8:00 AM

On Tuesday, Federal Reserve Chair Janet L. Yellen will testify before the Senate Banking, Housing and Urban Affairs Committee.On Jan. 31, Rep. Patrick T. McHenry (R-N.C.), vice chairman of the House Financial Services Committee, wrote a scathing letter to Yellen. Citing the clear message by President Donald Trump to put America first, he called on her to cease all international negotiations on regulations covering bank capital, systemic risk and other areas, and suggested that the Fed had no authority to engage in such activities.

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McHenry went on to call the Feds activities secretive, and suggested that its participation in international forums was killing American jobs. Hisletter echoes the heated rhetoric by President Trump during the campaign in which he said that Yellen should be ashamed of herself for keeping interest rates low for political reasons.

Such intervention by elected leaders is alarming for two reasons. First, research suggests that it is an America first strategy for the Fed to coordinate international financial regulation. Second, the Fed is an independent agency, and congressional leaders have generally refrained from directly threatening a sitting chair. I will explain below.

The Feds ability to negotiate international regulations helps ensure U.S. financial stability and competitiveness

One of the Feds key responsibilities is ensuring the stability of the financial system. It sets regulations for bank holding companies, which include most of the largest financial institutions in the United States, as well as many state-chartered banks and foreign banks with U.S. affiliates. Its independence enables the Fed to commit to a prudent set of policies without having to renege when politically expedient, thereby keeping inflation low and financial institutions resilient which, in a global economy, requires international cooperation.

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In my book, Regulating Capital: Setting Standards for the International Financial System, I chronicle 40 years of the Feds efforts to work with its foreign counterparts to set international standards for the worlds largest financial institutions.

Why create international standards? The financial system has become increasingly globalized, which means that the collapse of a major bank in London, Paris or Tokyo could cause U.S. banks to falter. International standards help level the playing field. Applying stringent regulations to U.S. banks would do little good if foreign banks were permitted to engage in risky behaviors. Without international standards, tightening U.S. regulations could give foreign banks a competitive advantage, thereby shifting capital and jobs overseas.

My research shows that the Fed has had tremendous influence over international standards on bank capital since the 1980s, ensuring that domestic efforts to prevent another financial crisis are not undercut by lax regulations in other parts of the world.

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The original cooperative agreement was the 1988 Basel Accord, an international agreement on bank capital and was the Feds solution to a thorny problem. The 1980s were a time of rampant bank failures. The Fed needed a way to shore up the banking system without jeopardizing the United States competitive advantage internationally. The Basel Accord allowed the Fed to enforce more stability-enhancing regulations domestically with the confidence that other countries would do the same.

My research builds on previous work by Thomas Oatley and Ethan Kapstein, who each emphasize U.S. regulators power to use international standards to force other countries to adjust their regulations.

The Feds international negotiations are not rogue or opaque. Although Congress did not have the perfect foresight in 1913 to explicitly mention international regulatory coordination in the Federal Reserve Act, it did specify in Section 13 of the Act that forging relationships with foreign central banks was critical for U.S. financial stability. Today, the Fed cooperates with nearly 30 countries on the Basel Committee on Banking Supervision and more than 30 countries on the Financial Stability Board.

Decisions by these bodies are not legally binding. Each countrys regulators must implement and enforce any regulatory standards that might emerge from international negotiations.

Contrary to McHenrys assertion in his letter, the Fed is transparent about its international activities. Its website contains extraordinarily detailed information about proposed rules. Moreover, it actively invites comments from affected banks and other institutions at each stage in an international negotiation.

The Feds independence enables it to focus on long-term U.S. financial health rather than short-term political positioning

The second area of concern is the integrity of the Feds monetary policymaking. Like most central banks in developed countries, the Fed is an independent government agency whose funding is not appropriated by Congress. The Feds members are nominated by the president, confirmed by the Senate and receive 14-year terms that cannot be cut short by anyone except the member. The chair is appointed to a four-year term with the possibility of reappointment. Yellens term as chair expires in January 2018.

All this insulates the Fed politically which helps ensure that interest-rate policy is designed for the countrys long-term health rather than short-term political gains by one side or another. Otherwise, elected leaders might pressure the Fed to lower interest rates in the months before an election, triggering a temporary boost to the economy and an uptick in the stock market. That would come at a cost. The Fed would lose its credibility, inflation would become increasingly difficult to manage and the value of the dollar could gyrate wildly.

Zimbabwes 90 sextillion percent inflation in 2008 is an extreme example of the effect of political interference on monetary policy.But research shows that central bank independence has beenhighly correlated with inflation in developed and developing countries since the 1950s.

All political threats to the Fed are serious. Its independence is a congressional creation, which means that Congress could take it away. But keeping the Fed independent and actively engaged in international coordination is the best way to maintain a stable and internationally competitive financial system in the 21st century.

David A. Singer is associate professor of political science at Massachusetts Institute of Technology and the author of Regulating Capital: Setting Standards for the International Financial System (Cornell University Press, 2010).

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Congress could limit the Fed's independence and hurt the US economy - Washington Post