Crises Are A Relationship Test for the Fed and Congress

A stroll through the central bank's recent relationship with Capitol Hill

Janet Yellen, chair of the U.S. Federal Reserve, speaks during a Senate Banking Committee hearing in Washington, D.C., U.S., on Tuesday, Feb. 24, 2015.

Photographer: Andrew Harrer

Lawmakers have intensified their scrutiny of the U.S. Federal Reserve in recent months. Legislation introduced by Massachusetts Democrat Elizabeth Warren and Louisiana Republican David Vitter would restrict the Fed’s emergency-lending powers.

Senate Banking Committee Chairman Richard Shelby has unveiled a bill that would create a congressional commission to examine whether the Fed needs structural changes, among other measures. Shelby's committee held a  mark up for the legislation Thursday, where it was approved in a party-line vote.

"The Fed was created over 100 years ago; it is probably time for a fresh look," Shelby said in a statement at the start of the session.

If the spate of significant legislative proposals pass, they'll mark a break from the past 25 years, when politicians took a slightly more hands-off approach and let former Fed Chairman Alan Greenspan operate. The relative quiet started to dissipate after the financial crisis of 2007 to 2009 forced the Fed into the spotlight and scrutiny. 

Such activism isn't unprecedented:  lawmakers pressured the Fed consistently in the late 1970s and early 1980s, when Chairman Paul Volcker pushed the main interest rate up to 20 percent as he waged war against inflation, for instance.   

"We constantly see shifts in the Congress' relationship to the Fed,'' said Peter Conti-Brown, an academic fellow at Stanford Law School's Rock Center for Corporate Governance. "What we're seeing right now is a whole batch of proposals and ideas that have been floating around for a long time that are becoming politically useful at a time when people are paying close attention to the Fed."

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Here are a few notable times since the Volcker era when politicians took extra interest in the Fed: 

1. 1978

The Humphrey-Hawkins Full Employment Act explicitly instructed the federal government, including the Fed, to strive for full employment. It ordered the Fed to submit to Congress a twice-annual written report on monetary policy. The period might have marked a time of "maximum action'' from Congress toward the central bank, said David M. Jones, president of DMJ Advisors LLC, a Denver-based economic consulting firm, and author of four books on the Fed.

2. 1981

Amid high interest rates and on the heels of an economic downturn, Senator Jim Sasser introduced a resolution urging the central bank to "reduce and institute alternative policies to restrain interest rates" and to abolish the Federal Open Market Committee. 

3. 1982

Senator Robert Byrd put forth draft legislation that would have forced the Fed to reduce interest rates, though it never moved on to become law. The Sasser and Byrd efforts show that there was a desire on Capitol Hill -- ultimately unfulfilled -- to meddle in monetary policy, not just adjust the Fed's structure.  

4. 1995

The Fed announced it would begin to release near-verbatim transcripts of its discussions that it releases with a 5-year time lag. This wasn't in response to actual legislation, but came after Henry Gonzalez, the Democratic chairman of the House Banking Committee in the early 1990s, pressured the central bank for greater transparency. Historians can now study actual internal Fed policy debates all the way back to 1976.

"Greenspan preempted Congressional moves,'' Conti-Brown said. "He was dragged kicking and screaming into the release of these transcripts."

5. 2010

Congress passed the Dodd-Frank Act. The legislation followed the financial crisis, which saw the Fed bail out ailing financial firms. Dodd-Frank charged the Fed with writing and enforcing new, stricter rules for banks and constrained the Fed's emergency lending powers to broad-based liquidity measures, as opposed to rescuing individual firms, and only with permission from the Treasury. 

The takeaway here is that economic crises revive scrutiny on the central bank, which is an independent agency of Congress. Pressure was strong during the Volcker's 1979-1987 reign when he allowed short-term interest rates to rise to double-digits to choke inflation out of the economy. It eased during the 1990's as Greenspan oversaw the longest expansion on record. 

The Fed's actions during the crisis "sort of stirred up the hornets' nest in Congress,'' Jones said. "It was the power of the Fed in fighting the great credit crisis of 2007 to 2009 that has triggered these arguments now."