On Politicizing the Fed . . .

As much as I disagree with the macro view currently being espoused by Merrill Lynch (too optimistic), I completely agree with their just-released view on tampering with the Fed.

This is a topic that was covered Friday by Bonddad, who compares Why the Audit the Fed Movement is the Equivalent of Economic Birthers.

Here is Merrill’s Senior US Economist on the Fed Audit:

“The Federal Reserve System is facing its most extensive scrutiny in several decades. Plans to audit the Fed’s monetary policy decisions are likely to raise expected and actual inflation, reduce financial stability, and undermine policy transparency. In our view, a significant erosion of Fed independence represents one of the greatest long-term risks to the outlook.

Just about every major central bank today conducts day-to-day policy — setting interest rate targets or some other policy instrument — without direct political oversight. The proposed audits of the Fed’s interest rate decisions do not directly compromise the Fed’s independence along this dimension, but they do represent a sizable step down the slippery slope of politicizing US monetary policy.

The current proposal is supposed to avoid direct political interference by imposing a six-month lag between Fed decisions and potential audits of those decisions. However, for policy to be pre-emptive, the Fed must start hiking before the economy has fully returned to normal. Moreover, moving from warning about a possible hike to finishing a tightening cycle can take the Fed several years. These policy lags give Congress ample opportunity to double-guess the Fed before the hiking cycle is completed. The mere hint of a delay in raising rates could ratchet up inflation expectations.

Politicians are not known for their restraint when it comes to manipulating the economy to gain potential votes. Most democracies have chronic budget deficits, and fiscal policy is often eased ahead of elections. Applying these same principles to monetary policy is a recipe for ever-escalating inflation.[…]

Criticizing the Fed once again seems to be a sure-fire way to gain votes this political cycle. But we think it is a far cry from a responsible way to implement sound economic policy.[…]

We think it is ironic that those who criticize the Fed for laissez faire policies earlier in the decade are now lining up behind a Fed audit proposal introduced by a devout libertarian. One, if not both, of these sides is bound to be disappointed with the likely consequences should it become law.

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Sources:
How not to fix the Fed
Michael S. Hanson, Senior US Economist
Merrill Lynch, 11 December 2009
http://www.ml.com/index.asp?id=7695_8137

Why the Audit the Fed Movement is the Equivalent of Economic Birthers
Hale Stewart
Bonddad Blog, December 11, 2009
http://bonddad.blogspot.com/2009/12/why-audit-fed-movement-is-equivalent-of.html