GOP War on the Fed Puts Bernanke on Defensive

GOP War on the Fed Puts Bernanke on Defensive

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Repeated Republican attacks on the Federal Reserve and Chairman Ben S. Bernanke have jarred Fed officials and prompted concern that the political assaults  could undermine the central bank’s effort to find new ways to boost the struggling U.S. economy.

People who work with Bernanke, including other policy makers, describe him as being troubled by the attacks and resolved to keep explaining and defending the Fed’s policies both in public and in private.

Former Massachusetts governor Mitt Romney and the seven other Republican presidential candidates have said they, if elected, would not reappoint Bernanke after his term expires  Jan. 31, 2014. A few have also signaled they would try to curtail the Fed’s independence by demanding greater transparency and  accountability to Congress.  Rep. Ron Paul, R-Tex., has repeatedly called for the abolition of the Federal Reserve – although few take that seriously. And Texas Gov. Rick Perry has called Bernanke’s  quantatative easing policies of buying up large amounts of bonds to lower long- term interest rates “treasonous.”

On Capitol Hill, meanwhile, Republican leaders have battered Federal Reserve policies and blocked President Obama’s efforts to fill two Fed vacancies, which now aren’t likely to be filled until after the 2012 election.

The Fed has just about exhausted its storehouse of monetary tools to jumpstart the economy,  although there are still  a few strategies left  that might help improve the economy around  the margins. But the steady anti-Fed drumbeat by GOP presidential candidates and lawmakers may have left Fed officials gunshy about doing anything more  before the election that would increase the size of the central bank’s balance sheet.

“On the margin, such attacks make it more difficult for the Fed to do its job,” Ray Stone of Stone & McCarthy Research Associates told The Fiscal Times last week. “It can’t help. It’s possible that one of these guys will become the next president.”

In the short run, the political pressure has created some uncertainty in investors’ minds whether the Fed might become more cautious in its actions to avoid further criticism. So far there’s no indication of that happening, but anything that adds to uncertainty in the current economic situation can be damaging.

The Fed is caught up in a Republican effort to shift major responsibility for the financial crisis and  what they have deemed  ineffective and costly measures for dealing with the recession to Obama, Democratic lawmakers  and the central bank.

At  last week’s GOP debate at Dartmouth College in New Hampshire, former House Speaker Newt Gingrich accused Bernanke of secretly spending “hundreds of billions of dollars bailing out one group and not bailing out another group,” adding, “I think it is corrupt and it is wrong for one man to have that kind of secret power.” The remarks drew applause from the audience.

From the beginning of his chairmanship in 2006, Bernanke has gone to great lengths to create a collegial approach to policy, and even the officials who have dissented on some policy moves generally praise his strong leadership. 

Bernanke weathered an even more serious attack on the Fed’s power during the lengthy negotiations over the Dodd-Frank bill to tighten regulation of financial institutions. In 2009 numerous members of Congress in both parties argued that the Fed should be stripped of virtually all its authority except to set monetary policy. In the end, however, the Fed actually was given sweeping new authority over matters affecting financial stability simply because no other part of government appeared competent to handle that role.

During that period, and more recently, Bernanke has met repeatedly in private with members of Congress to respond to their concerns -- in at least one case with surprising success. In September he spent time with House Speaker John Boehner, who then broke ranks with the many Bernanke critics in his party.

In a television interview later that day, the speaker said of Bernanke, "I'm glad he's there." The chairman is in a "critical job at a very difficult time not only for our economy, but around the world," said Boehner, who added that he had endorsed Bernanke’s reappointment and has no regrets for doing so.

However, only days later Boehner joined House Majority Leader Eric Cantor, Senate Minority Leader Mitch McConnell and Sen. John Kyl, the minority whip, in sending Bernanke an unprecedented letter telling him not to take further steps to lower interest rates because doing so “may erode the already weakened U.S. dollar or promote more borrowing by overleveraged consumers.”

The letter, sent during a two-day meeting of the Federal Open Market Committee, the central bank’s top policy making group, was an attempt to dictate monetary policy with an implicit threat of retaliation. Under the Constitution, Congress has authority over monetary matters and the Fed is part of the congressional branch of government.

The FOMC nevertheless went ahead with a plan to reduce longer-term rates by selling about $400 billion worth of short-term Treasuries and buying longer-term ones. However, three of the five reserve bank presidents currently in the voting rotation—others vote at two- or three-year intervals—dissented. They argued the step effort, which quickly became known as Operation Twist, was not needed or wouldn’t do any good.

Eric Rosengren, president of the Boston Federal Reserve Bank, a non-voter who said he was “very supportive of the actions,” noted in a recent speech that announcement of the plan caused yields on 30-year Treasury bonds to fall by 18 basis points and 30-year mortgage rates to drop 22 basis points, both significant movements. A basis point is one one-hundredth of a percentage point. 

This politicization of monetary policy has also extended to the refusal to confirm qualified candidates to fill the two Board vacancies. Sen. Richard Shelby, the ranking Republican on the Senate Banking Committee, blocked confirmation of President Obama’s nomination of economist Peter Diamond of the Massachusetts Institute of Technology, a Nobel Laureate, on the grounds he was not qualified because he was not an expert on monetary policy.

These seats are almost certain to remain vacant until after the election, which would give a Republican president an immediate opportunity to begin reshaping the makeup of the Fed.

In testimony two weeks ago before Congress’ Joint Economic Committee, Bernanke implicitly indicated the Fed would continue to ignore the exhortations in the Republican congressional leaders’ letter. He said the FOMC “will continue to closely monitor economic developments and is prepared to take further action as appropriate to promote a stronger economic recovery in a context of price stability. ” During the Sept. 21 FOMC meeting, he said that further actions that could be taken would be:

  1. To reduce the quarter-percentage point interest rate being paid on excess bank reserves.
  2. To expand the Fed’s $2.8 trillion balance sheet through additional purchases of Treasury or mortgage-backed securities.
  3. To change Fed communications, such as making more explicit the types of economic developments that could cause the committee to alter its policies in the future.

Most Fed observers think reducing interest paid on reserves is very unlikely since it would have a very adverse impact on money market funds that provide liquidity to banks. Since the size of the balance sheet is already a sore point with many Fed critics, the committee would probably be reluctant to do a third round of what is known as quantitative easing. That probably makes some further change in the communication strategy the most likely next step—if there is one.