Goldman Warns, Congress Is Preparing To Tame The Fed
Having already warned that looming political uncertainty is not at all priced-in to US equities, Goldman's Alec Phillips points out that legislation was introduced earlier this week (July 7) in the US House that would attempt to revamp the FOMC's monetary policy process. The bill would require the FOMC to justify to Congress each policy decision relative to a Taylor rule specified in the legislation. While Goldman, do not expect the bill to get very far, but the issue does appear to be a growing focus for some lawmakers and we expect further action on it in the near term.
Via Goldman Sachs,
- Legislation was introduced earlier this week (July 7) in the US House that would attempt to revamp the FOMC's monetary policy process. The bill would require the FOMC to justify to Congress each policy decision relative to a Taylor rule specified in the legislation.
- These proposals may attract some attention as they make their way through the legislative process, particularly since the House committee seems likely to pass the bill in the next few weeks. However, the bill is less likely to pass in the full House of Representatives before the November election, and it seems to us very unlikely that the Senate would consider it this year so the probability of enactment appears very low.
- Earlier this week, two members of the House Financial Services Committee, Reps. Huizenga (R-MI) and Garrett (R-NJ), introduced legislation that would impose new requirements on the Federal Reserve and the FOMC. We do not expect the bill to get very far, but the issue does appear to be a growing focus for some lawmakers and we expect further action on it in the near term.
The bill presumes a Taylor rule for the Fed
The most important change the bill proposes would be to require the FOMC justify its policy decisions to Congress with reference to a Taylor rule. Specifically, the bill would establish a new requirement that the FOMC submit to Congress a report on monetary policy within two days after each FOMC meeting. The report would include a detailed quantitative description of the policy rule the FOMC is following, including whether the fed funds rate, the rate of interest on excess reserves, and/or the discount rate is being targeted, and how the targeted values would change under different inflation and GDP assumptions.
The bill would require the FOMC to explain its own policy rule in relation to a rule like the one Stanford Professor John Taylor described in 1993, where the nominal federal funds rate equals 2% plus the sum of (a) the inflation rate over the prior 4 quarters, (b) one-half of the estimated output gap in percentage terms, and (c) one-half of the difference between the rate of inflation over the prior 4 quarters and 2%. To the extent that the policy rule the FOMC submits under the requirement does not conform to this reference rule, the FOMC would be required to submit a "detailed justification" of the departure from the rule. The legislation would require the Government Accountability Office (GAO) to conduct an analysis and report to Congress on whether the FOMC had complied with the requirements laid out in the legislation. If the FOMC were found to be out of compliance with these requirements, the Federal Reserve Chair would be required to testify in Congress and the FOMC would be subject to an audit by the GAO.
The practical implication of the bill would be that while the FOMC could continue to operate as it currently does, if it opted out of the process established in the bill it could become subject to periodic audits and the Fed chair would have to testify before Congress quite often, potentially after each FOMC meeting (the bill, in a separate section, would increase the semi-annual Humphrey Hawkins testimony to four times a year in any case). In the past, Fed officials have been clear in their opposition to prior proposals to require an audit of monetary policy decisions and we assume the Fed would oppose the recently introduced legislation though we are not aware of any specific comments from the Fed on it.
Further near term action seems likely but enactment is unlikely
The Committee held a hearing on the legislation today (July 10). No vote has been scheduled yet, but we expect the House Financial Services Committee to vote on the bill in the next few weeks. We assume it will pass along mostly party lines. Whether it will receive a vote on the House floor is less clear, since the legislative agenda will be crowded during the limited time Congress will be in session in July and September (the House will be in session for only 25 days between now and the midterm election on November 4). More importantly, regardless of whether the House passes the bill or not, there appears to be very little chance that the Senate would consider, let alone pass, the bill this year.
Next year, if the Republicans manage to take the Senate majority following the midterm election, there might be somewhat greater pressure to hold a vote in that chamber if the House were to pass the legislation. However, even in this case it is far from clear that there would be sufficient support in the Senate, where 60 votes are normally required. Moreover, in the unlikely event that such legislation managed to pass in the Senate, we would expect President Obama to veto it.
Of course, it would not be unprecedented for Congress to amend the Federal Reserve's mandate regarding monetary policy, though it happened only rarely. The last time Congress enacted significant new monetary policy-related requirements was in 1977 and 1978, when Congress reworked the Fed's mandate, required the Federal Reserve Chair to testify semiannually to House and Senate Banking Committees, and established a four-year term, confirmed by the Senate, for the Federal Reserve Chairman and Vice Chairman, among other changes. However, not only was the economic situation different at that point, the political situation at the time very different from the current one as well: both chambers of Congress were controlled by the recently elected President's party, while the Fed Chairman had been appointed by the prior administration.
There has in fact been some bipartisan support over the past few years for much simpler legislation first offered by Rep. Ron Paul (R-TX) to remove the prohibition on GAO audits of monetary policy deliberations. That said, support for more recent efforts appears to be falling along party lines more than it used to. For example, while Rep. Paul's legislation passed the House in 2012 by a vote of 328 to 98, a nearly identical version of that legislation in the current Congress has been co-sponsored mainly by Republicans. The upshot is that while the issue seems likely to remain a subject of political interest among lawmakers, these sorts of policy changes appear unlikely to be enacted into law in the foreseeable future.
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The simple question we have is - why is Goldman Sachs bringing this up now?
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