The Fed's Role In Crisis And Recovery

Despite its apolitical mandate, the Federal Reserve remains one of the most politically sensitive institutions in the world, as evidenced by Fed Chairman Ben Bernanke's opinion column on November 29th. In the piece, Bernanke criticized proposed legislation before the Senate that would seek to curtail powers given to the Fed over its near-century of existence. With approval of the Consumer Financial Protection Agency comes a new regulatory regime that may also threaten the dominant paradigm, changing the way business at the top is done for decades to come. What will the Federal Reserve's role be in this new financial landscape, and how effective will they be in the face of continuing economic uncertainty?

The Fed's mission is to balance between the twin specters of inflation and unemployment, which sets it apart from other central banks around the world, who usually focus primarily on inflation. This means that the Fed is seen as accountable for job growth and productivity in good times, as Alan Greenspan often did over his tenure as chairman. In tougher times, the US central bank assumes responsibility for propping up spending, as it did over the past two years of recession. By most measures, the unemployment target is far off, at a 20+ year high of 10.2 percent, when compared with short and medium-term inflation expectations. However, the Fed has remained somewhat quiet on the issue, likely fearing increasingly vocal calls for reform that have followed the heels of the financial crisis. By focusing on inflation, the Fed is acknowledging a tacit understanding that the recession has made clear: Central banks are responsible for banks, and the government is responsible for consumers.

Evidence for this strategy is everywhere, from the fiscal stimulus package to the continuing low borrowing costs for financial institutions. Many new tools created to address the credit crunch are now being unwound, with taxpayer leverage bearing the costs, most visibly through the TARP paybacks made recently. While the White House may browbeat bank CEOs to increase small business lending, the likely impact is minimal now that the finance industry is back on more sure footing. This leaves the Fed as the primary entity responsible for transparency for other banks. Yet legislation allows the Fed considerable leeway when it comes to publishing their decisions about interest rates and discount window offerings. An obvious need for oversight cannot result in further politicization of the central bank, but any choice for reform will necessitate political compromise, further complicating the issue. Some have called for Ben Bernanke's resignation as a way to change direction, but even with new management the Fed's hands have been made to seem tied. By exerting as little political involvement as possible, any movement on the Fed's part to bring their expertise to financial regulation will result in political cost which they cannot bear. If they try to expand small-business lending through their balance sheet, they further run the risk of stoking inflation, another politically risky move. But little options seem available, now that the economy has begun to improve and banks have less impetus to reform themselves. But if one assumes that unemployment is a high priority now, imagine what next year's congressional elections will look like. At least the Fed's directors are appointed.

By: Dane Smith

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