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H.R. 3512 AND H.R. 3066

Thursday, November 9, 1989

HOUSE OF REPRESENTATIVES,

SUBCOMMITTEE ON DOMESTIC MONETARY POLICY,

COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS,

Washington, DC. The subcommittee met at 9:35 a.m., pursuant to notice, in room 2222, Rayburn House Office Building, Hon. Stephen L. Neal [chairman of the subcommittee] presiding.

Present: Chairman Neal, Representatives Barnard, Leach, and McCollum.

Chairman NEAL. I would like to call the subcommittee to order at this time.

The subcommittee meets this morning to hear testimony from a number of witnesses on legislative proposals to alter of the institutional structures and procedures of the Federal Reserve System.

The common concern underlying these proposals seems to be, and I think clearly is accountability. We all appreciate that the major policymaking institutions of a democracy should be accountable to the people either directly through elections or indirectly through control by elected officials.

Since the Federal Reserve is not under the direct control of elected officials, it might appear to escape the necessary or desirable degree of accountability. Much of the discussion on accountability centers on mechanisms, procedures and institutional arrangements. The key question seems to be how should accountability be enhanced.

There is, however, a more basic question, namely, for what should the Federal Reserve be accountable? Answering that question clearly and unambiguously is the prerequisite, it seems to me, for finding the optimal institutional mechanisms for accountability. My own answer to that basic question is put forward in my resolution, H. J. Res. 409, legislation which would establish price stability and zero inflation as the objective of monetary policy. We will be doing more hearings on this legislation. So I won't dwell on it here.

Most of today's testimony will be on H.R. 3512 and H.R. 3066. I suggest, however, that the proper framework for evaluating these proposals should always be the question do they promote or undermine the Federal Reserve's ability to accomplish its basic purpose, and that of course leads us squarely to the question of what that basic purpose is or ought to be.

We have quite a few witnesses today, and we will proceed with several panels.

(1)

First, I'm delighted to welcome my distinguished colleagues, the Honorable Byron Dorgan, the Honorable Lee Hamilton and the Honorable Lane Evans.

Mr. Dorgan and Mr. Hamilton have coauthored H.R. 3512, and Mr. Evans is the author of H.R. 3066. After we hear from them, we will turn to a panel of two very distinguished economists, Professor James Tobin from Yale University and Lyle Gramley, a former Governor of the Federal Reserve System, who is now Chief Economist for the Mortgage Bankers Association. Then we will hear from Mr. Milton Socolar, special assistant to the Comptroller General, and finally we will conclude the day with testimony from two public policy organizations that have requested to testify, Public Citizen and Liberty Lobby.

At this time we will begin with Mr. Hamilton, then Mr. Dorgan and then Mr. Evans, if that is satisfactory. We will put your entire statements in the record and ask that you proceed as you will.

STATEMENT OF THE HON. LEE H. HAMILTON, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF INDIANA Mr. HAMILTON. Thank you very much, Mr. Chairman.

Before I begin my testimony on H.R. 3512, let me simply commend you for introducing H. J. Res. 409. During the past few years we have come to accept 4 percent inflation as normal. That's too high.

As Chairman Greenspan testified in his appearance before your subcommittee, the Federal Reserve has been entrusted with a number of responsibilities for the functioning of the economy. Price stability is one of those responsibilities as is low unemployment and steady economic growth and a competitive dollar.

In recent years Congress and the administration have not given the Federal Reserve much help in carrying out these responsibilities. Budget deficits have been too high, fiscal policies have been immobilized and the complex task of managing the economy has been left up to the Fed. Against great odds the Federal Reserve has done a good job in conducting monetary policy to achieve the nation's complex set of economic goals. Zero inflation may not be the only economic goal of the nation, but it certainly is of central importance, and I commend you for that resolution.

As you know, Mr. Chairman, we are here to testify today with respect to H.R. 3512.

The Federal Reserve occupies an anomalous position within the Government of the United States. It is an enormously powerful institution, but it does not conform to the normal standards of Government accountability. Power without accountability simply does not fit into the American system of democracy.

Through its control over monetary policy the Federal Reserve affects the lives of all Americans. It has the power to decide who prospers and who fails. The path that the Federal Reserve sets for monetary policy and interest rates affects every businessman and woman, worker, consumer, borrower and lender in the United States.

The dilemma has been very well stated in your opening statement. The dilemma created by this concentration of power is that

the independence which the Federal Reserve must have in order to insulate monetary policy from political pressures also removes the Fed from the normal processes of accountability that apply to every other agency of the Federal Government.

Our bill addresses, then, a very difficult and perplexing problem-how to make the Federal Reserve more accountable to the American people without jeopardizing its independence and its ability to conduct monetary policy free of political pressure.

When Congress and the President make policy, we do it in the open. The debates in both the House and the Senate are televised throughout the country. The decisions we make are immediately reported to the American people, every penny the Government spends shows up in the budget documents of the U.S. Government and this information is readily available to any interested Member of Congress or the public, and the books and programs of every Government agency are subject to audit and review by the General Accounting Office. These are the accepted rules of accountability in a democracy.

But these rules do not apply to the Federal Reserve. The Fed is independent of the rest of the Government. It was purposely created that way to insulate monetary policy from political pressures. No other Government agency enjoys the Fed's prerogatives. Monetary policy is conducted in secret behind closed doors. The Federal Reserve is not required to consult with Congress or the administration before setting money or interest rates targets even though its power affects every American. It waits 6 weeks before releasing policy decisions.

The President, who is responsible for the performance of the economy and is blamed if things go wrong, often must wait until late in his term to appoint a new Chairman of the Federal Reserve Board, raising the risk that the President and the Federal Reserve Board Chairman might be at odds. President Bush, for example, will not be able to appoint a Fed Chairman until August 1991.

The Fed's budget is not published in the U.S. Government Budget, even though it spends over $1.5 billion a year. Only 6 percent of the Federal Reserve's expenditures are detailed in the U.S. Government Budget, the $90 million spent by the Board of Governors, and this appears only in the appendix and not in standard Government format.

The Presidents of the 12 Federal Reserve Banks who participate in monetary policy decisions on the FOMC are neither appointed by the President nor confirmed by the Senate. Even though the Federal Reserve engages in more than $1 trillion in transactions in the money markets each year, most of these activities are exempt from audit by the GAO or any other outside agency.

The bill that Congressman Dorgan and I have introduced is an attempt to address this very complex issue of Federal Reserve accountability. Before describing the bill, let me tell you what it will do not.

First, it will not cause revolutionary changes in the Federal Reserve. It's a very modest bill designed to improve some of the Federal Reserve's practices and procedures.

Second, our bill will not reduce the policymaking independent of the Fed or inject politics into monetary policy. The bill does not

impose Presidential or congressional or other outside controls on Fed policy.

Instead, it aims to make the Federal Reserve more accountable to the American people, not by giving politicians control, but by creating a formal channel of communication between the President and the Federal Reserve and by providing Congress and the American people with more and better information on the Federal Reserve's policies and procedures.

Let me go through the several provisions of the bill.

First, it would require the Secretary of the Treasury, the Chairman of the Council of Economic Advisers and the Director of the Office of Management and Budget to meet three times a year on a nonvoting basis with the FOMC to consult on monetary and fiscal policy.

The purpose of the meetings is to improve the flow of information between the administration and the Federal Reserve.

In his testimony before the subcommittee on October 25th, Federal Reserve Board Chairman Greenspan opposed this provision on the grounds that the Federal Reserve and the administration already communicate through informal channels and that the more formal arrangement proposed by our bill would result in political manipulation of monetary policy.

Informal channels of communication do exist. For example, the current Fed Chairman and Treasury Secretary are reported to meet about once a week. Over the years, however, the success of informal methods has varied, depending on the personalities involved. In addition, the discussions are off the record and views are conveyed by the Chairman secondhand to other members of the FOMC.

This ad hoc approach to making decisions which affect the economic well-being of all Americans is not the best way for a great economic power to conduct its business. It is astonishing that the world's major economic power does not have a formal channel of communication between the key makers of economic policy. Our bill would establish a channel of communication that would not depend on personalities for success.

Now it's interesting to note that the Fed is already required to conduct formal advisory meetings of the kind we propose with a number of outside groups, the Federal Advisory Council composed of 12 private sector bank presidents, the Consumer Advisory Council and the Thrift Institutions Advisory Council.

The Fed does not object to meeting regularly with bank presidents, consumer representatives and the thrift industry to discuss issues of importance to these groups. Why not accord representatives of the President of the United States the same privilege to discuss issues of paramount economic importance to the whole Nation?

Contrary to Chairman Greenspan's fears, three FOMC meetings a year with the administration's top economic advisers will not empower the President to meddle with monetary policy. The required meetings would occur before actual FOMC meetings. No member of the administration would be present when the FOMC makes policy decisions and none would have a vote on the FOMC. The format of the meetings would be solely under the control of the participants.

Furthermore, given the Federal Reserve's current concern for its independence, any attempt by the administration to meddle in monetary policy would and should evoke a strong reaction from the members of the FOMC.

If Chairman Greenspan raised this issue because he fears that the President through his three representatives could successfully dictate monetary policy, his words cast a dark cloud over the independence of the members of the FOMC.

Secondly, the term of the Federal Reserve Chairman.

Our bill would allow the President to appoint a Chairman of the Federal Reserve Board 1 year after taking office, at the time when the first regular opening would occur on the Federal Reserve Board. This would make the Fed Chairman's term basically coterminous with the term of office of the President.

The current Chairman of the Board of Governors, Mr. Greenspan, was appointed by President Bush's predecessor and will hold that office until August 10th, 1991, almost 3 years into President Bush's term. Fortunately, Chairman Greenspan and President Bush have a cordial relationship. The fact that Mr. Greenspan was not appointed by President Bush has not caused any significant problems with monetary policy. But if they were unable to work together, the result could be serious damage to the American economy and a paralysis of economic policy. Why take that risk?

Chairman Greenspan testified that linking the Chairman's term to the President's could result in less independence from the White House than currently exists. To the contrary, the provision in our bill would not increase the President's influence over the Federal Reserve. A Fed Chairman who was appointed 1 year after the President took office and knew he would not come up for reappointment during the President's term would have much more independence than one, such as Chairman Greenspan, who must conduct policy to please President Bush if he wants to be reappointed Chairman when his term expires in 1991. In addition, over the years, some Chairmen have been appointed soon after the President took office with no detrimental effects.

The Federal Reserve's position on this issue has varied over the years. I'll not go into that, Mr. Chairman, in detail. Mr. William McChesney Martin believed that the terms of the Chairman and Vice Chairman should be related to the President's term of office. Chairman Burns I guess was of two minds on it, and Chairman Volker testified in support of the change in the Chairman's term that our bill would make.

The third provision relates to the disclosure of monetary policy decisions.

Our bill would require the FOMC to disclose immediately any changes in the targets of monetary policy, including its targets for monetary aggregates, credit aggregates, prices, interest rates or bank reserves.

The FOMC currently keeps major policy decisions secret for 6 weeks after they are made and carried out. While secrecy may help insulate the Federal Reserve from criticism, secrecy has two economic costs.

First, secrecy makes capital markets operate less efficiently. The Federal Reserve's position on this can be defended only if you be

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