One of the most important ideas in the United States government is the
separation of powers, and the role that each branch of government performs.
Briefly described, Congress makes the laws, the President enforces laws, and
the Courts ensure laws are administered justly.
When it comes to the Federal Reserve, however, it exists by creation of
Congress and is charged with a mandate of maximum sustainable growth and
maximum employment. The appointment process is a political one: with the
Chairman appointed by the President and confirmed by the Senate every four
years, and the Governors appointed and confirmed in a staggered manner every 14
years. These appointments are specifically spaced in order to create a feeling
of independence with the Federal Reserve, so that it may be free from external
political influences in pursuit of its main policy objectives.
Yesterday, Secretary Tim Geithner and Professor Lawrence Summers suggested
in a Washington Post op-ed that the Federal Reserve would be the best choice to
serve a regulator of “systemic risk.”
The first question one must ask is what, exactly, constitutes a systemic
risk. I suggest the definition mirrors that of Justice Potter Stewart when
describing pornography: “I know it when I see it.” This famous, yet unhelpful,
definition shows a fallacy in the idea of systemic risk; what is systemic risk
to one person is merely the failure of an unprofitable and poorly managed
institution to another.
More importantly, making the Federal Reserve perform the actions of a
regulator is likely to compromise its independence, as it will be performing a
function that is reserved for the Executive Branch. Rather than being allowed
to focus exclusively on its current mandate, appointment as a regulator is
likely to create an organizational feeling of subordination, where the Federal
Reserve over time views itself as a policy implementation tool of the Executive
While the Framers intended each branch of government to be equal and moderately
adversarial, the implications of the Legislative and Executive branch passing
Keynesian policy with the Federal Reserve complicit is a sure path to ruin. In
a sense, this is what is going on right now, with the Federal Reserve agreeing
to buy treasuries in order to fund the additional debt obligations of the
government. While perhaps a necessary evil in the short term, the implications
of this as a long-term policy are disastrous.
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