Republican Bill Seeks Monetary Policy Rule for Fed

House Republicans proposed legislation to limit how the Federal Reserve makes monetary policy, a week before Chair Janet Yellen is scheduled to deliver her semiannual testimony to lawmakers.

The draft bill announced today in Washington would require the policy-setting Federal Open Market Committee to describe a strategy or rule for how it would adjust interest rates. Currently, the Fed doesn’t bind itself to a formula, preferring flexibility in an economy that continues to elude their forecasts of where it is headed.

“It’s broadly consistent with Republicans’ continued anger with the Fed and seems to reflect a continuing concern that it’s time for the Fed to get further down the exit path and start raising rates,” said Sarah Binder, a senior fellow in governance studies at the Brookings Institution in Washington who specializes in studying Congress’s relationship with the central bank.

While it has little chance of passing in a Senate controlled by Democrats, the bill signals Republican interest in a more constrained and transparent Fed as it closes one of the most expansive periods in its 100-year history. Policy makers have kept the benchmark interest rate near zero for five years and used bond purchases to hold down long-term borrowing costs, expanding their balance sheet to a record $4.38 trillion in the process.

Yellen will deliver her semi-annual monetary policy testimony before the Senate Banking Committee on July 15 and to the House Committee on Financial Services the next day.

‘Little Needle’

“It’s just designed to put a little needle under the Fed, but I just think it’s for show,” said Greg Valliere, who coordinates political and economic research as chief political strategist for Potomac Research Group in Washington. “It does send a subtle shot to Yellen and the Fed that they’re being watched and their policies are not all that popular among a lot of Republicans.”

The bill is sponsored by Republicans Bill Huizenga of Michigan, a vice chairman of the financial services subcommittee on monetary policy, and Scott Garrett of New Jersey, who earlier filed a bill that would require the Fed to disclose more about the supervision of the biggest, riskiest banks.

Policy Instruments

The legislation defines Fed policy instruments as the federal funds rate, interest on excess reserves, and the rate banks pay to borrow directly from the Fed. It omits reverse repurchase agreement rates, a tool the Fed is planning to use to help it raise other market rates as it tightens monetary policy.

Minneapolis Fed President Narayana Kocherlakota told reporters after a speech in his bank’s home city that the Fed already has a policy rule in its mandate from Congress to achieve full employment and stable prices, which the central bank defines as inflation of 2 percent.

“We should be meeting that rule,” he said. “I’m very comfortable with that.”

The proposal, inspired by the rules-based approach of Stanford University economist John Taylor, expands earlier Republican efforts to curb Fed power.

Romney Adviser

Taylor, who published a 2011 essay in the Cato Journal titled “Legislating a Rule for Monetary Policy,” will testify before the financial services committee this week. He served as a top economic adviser to Republican presidential candidate Mitt Romney in 2012.

Taylor, author of a monetary policy rule that bears his name, has argued that the economy fares better when policy makers pursue a systematic approach that reduces the chances of error. His rule, developed in 1993, sets the main interest rate based on the rate of inflation and the gap between the economy’s potential and actual level of output.

Under the bill, the FOMC would be required to submit its rule to Congress. The legislation leaves the strategy up to the Fed, although any changes in the rule would trigger an audit.

The bill would also require more transparency on the Fed’s bank oversight and would require the Fed chair to testify before Congress quarterly, instead of twice a year as the law now specifies.

Mandates, Powers

Financial services committee Chairman Jeb Hensarling, a Republican from Texas, said in December he plans to subject the Fed to unprecedented scrutiny while considering legislation that may focus on its structure, mandates and powers.

The Fed came under tougher congressional oversight during the 2008 financial crisis as it rescued Bear Stearns Cos. and insurer American International Group Inc., and created credit mechanisms to support money-market funds and markets for commercial paper and securitizations.

To contact the reporters on this story: Craig Torres in Washington at ctorres3@bloomberg.net; Jeff Kearns in Washington at jkearns3@bloomberg.net

To contact the editors responsible for this story: Chris Wellisz at cwellisz@bloomberg.net

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