Andrew Levin and Christina Parajon Skinner on *Central Bank Undersight: Assessing the Fed’s Accountability to Congress*

Andy Levin is a professor of economics at Dartmouth University and a former senior staffer at the Federal Reserve Board of Governors. Christina Parajon Skinner is a legal scholar at the University of Pennsylvania and formerly was legal counsel to the Bank of England. Andy and Christina have co-authored a new article titled, *Central Bank Undersight: Assessing the Fed’s Accountability to Congress,* and they rejoin David on Macro Musings to talk about it. Specifically, they discuss the Fed’s power under a constitutional authority, the three sources of Fed undersight, proposals for reform, and more.

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth:  Welcome back, Andy and Christina.

Christina Parajon Skinner: Thanks for having us, David.

David: Well, this was a very interesting article to read, and some might call it provocative, because in the very title it says, central bank “undersight”, as opposed to oversight, which is what you guys are getting at. I'm curious to hear the motivation for this very, for some, provocative paper.

The Motivations for *Central Bank Undersight*

Christina: I guess you can say that with our title, we're certainly not burying the lede, our lede. So, I think it's really helpful, probably, for the listeners to start out with the very big picture, and then we can talk about our respective motivations for coming together and collaborating on this project. Big picture, the question that we're trying to get at here is whether Congress's oversight tools, capacity, attention, are really fit for purpose, for overseeing a modern Fed, a central bank that's really changed a lot in the past 15 years. Is Congress still thinking about Fed oversight like it did in the '90s or in the early 00s?

Christina: If you take a step back, you see that the Fed today has incredible room to maneuver with its balance sheet, to innovate new monetary policy tools, to expand existing ones in creative ways, and I think it's important to underscore at the outset that we're not saying that they shouldn't be doing this or that certain policy choices were wrong. That's not really the point of the paper. We're trying to underline for people that in our system of government, the Fed, like all independent administrative agencies, is really an agent of Congress, and Congress has an important constitutional responsibility to oversee its agent.

Christina: And so, the question is, is Congress doing that job well for the American people? Can it do that job well today with the statutory tools that it has? And has the Fed's governance itself changed in ways that make some of these tools obsolete or too blunt? And so that's really what we're getting at here. We're not trying to Monday morning quarterback QE or anything, but we're trying to ask whether there's an adequate process in place to evaluate decision-making around these really major economic policy choices.

David: Andy, what about you?

Andrew Levin: I'll just say, first of all, it's great to be with you today, David. I appreciate your wisdom in having all of these podcasts and helping many people around the world to stay up to speed with these issues. It was really a privilege, to me, to work with Christina on this project. I, of course, have been thinking about monetary policy issues for decades, but to engage with a brilliant legal scholar like Christina, who's really delved into the constitutional issues and the legal issues and the legal history of these things.

Andrew: And Christina's written a number of important papers on financial regulation and other aspects of the Fed. I think what was fun for me in working together on this was to really think hard about the monetary policy framework and really severing out that issue. The paper doesn't deal with questions about the Fed's regulatory responsibilities or its role in the payment system. In fact, Christina's finishing some new work on that that she's going to present later this spring, which I'm really excited about.

Andrew: This paper is just focused on monetary policy. So, I think that, because I'm pretty old, I remember when the work among economists on central bank independence was starting to emerge in the '80s. And I think, at the time, there was a pretty clear understanding that the central bank is an agency of elected officials in a democratic society. And so the word independence was jargon among economists.

Andrew: With that understanding, Milton Friedman emphasizes very clearly in his work, and [among] all of the pioneers in that literature in the '80s and '90s, no one was saying that the central bank should be a philosopher king. Everyone was understanding that the central bank ultimately reports to elected officials. The challenge was, how do you give the central bank a mandate and authority that protects it from political interference and prevents election, kind of, political business cycles and prevents the things that we saw in the '70s with Nixon meeting with Chairman Burns in the Oval Office and discussing how the Fed could help reelect him. There was a clear understanding that that's just out of line.

Andrew: But I think that part of the problem here is that the profession, the economics profession, the monetary economics profession, has come around to this view of independence as closer and closer to absolute. There's no conversation anymore about, is there accountability? What's the mechanism through which elected officials oversee the monetary policy decisions? And so, I think that was an important part of the thinking that Christina and I were— Again, she's coming in as a legal scholar. I'm coming in as the monetary economist— but trying to collaborate together to raise these issues and hopefully start some more discussion about this.

Christina: I think that's exactly right, Andy. Likewise, it's been such a privilege to work with you and learn from your experience. I think it's really important to underscore here that the concept of central bank independence, as you rightly say, has always been enmeshed in this notion that independence has to be coupled with accountability. It's not the case that accountability is the antithesis of independence, but rather accountability is what legitimizes an agency's independence in a constitutional democracy. We talk a lot about central bank independence, especially from the perspective of policy optimality, but we haven't given sufficient attention to what accountability, in the specific case of the Federal Reserve, looks like. That's really what we're trying to shine a light on here and encourage really productive debate about what this should look like today.

David: I think that's an important issue, and it’s a theme that we come back to on this podcast very often, and that is protecting central bank independence and in doing that, as you alluded to just now and in your paper, you have got to have that democratic accountability. Otherwise, you do undermine that, and we see that. At least I see that from where I sit with the increased politicization of all federal agencies, but the Federal Reserve in particular. It does concern me that as we get different people elected to office, we're going to swing from one direction to the other direction, and how do we insulate against that? One way is to adopt some of these proposals that you guys address in here. One last question about the paper, though. How did you guys actually connect? We've got a legal scholar. We've got a monetary economist. I know you both write on the Federal Reserve, so you probably have read each other's papers before, but how did you guys actually come together?

Christina: I believe we initially met-- Andy, you'll have to correct me if I'm wrong, but this project grew out of a very early stage thought project that we had engaged in together with Charles Calomiris and Charles Plosser. We had started maybe 18 months ago, two years ago even, thinking about even bigger picture questions surrounding the Fed's governance structure; thinking about how the regional reserve banks were an important, but perhaps waning source of structural independence within the Federal Reserve system, and thinking about some of these really big picture questions, whether Congress was effectively equipped with information to ask pointed and effective questions at hearings and so on and so forth.

Christina: And from that— multi-session meetings that we had, sort of throwing around ideas— Andy and I decided to come together and put this into a law journal article format, specifically. That's pretty much the story. And the funny story is that we had actually worked together in that early stage process and through the drafting of the paper and only actually met in person, I think, in December, when Andy presented the paper in New York City which just, again, emphasizes the power of post-COVID work collaboration through Zoom, I suppose.

David: So, I will note to our listeners that if you read this paper, you'll see that it's been presented quite a few times already, and we'll provide a [show note link] to the paper so that listeners can go check it out. So, what has been the response to it? Because, again, this is a very provocative title. And, again, the hope of the paper is actually to preserve central bank independence, but nonetheless, it can come across as provocative to some. So, I'm just curious, kind of overall, what has been the response to the paper?

Responses to *Central Bank Undersight*

Andrew: If I can just jump in, and to follow up on what Christina was saying, part of the framing of the paper was not to raise questions about the current governance structure or the current mandate. The paper just takes those as given. I think Christina's been speaking a lot, and I have too, about potential reforms that could be considered, but the paper just doesn't go there. The paper does ask the question of, if the current mechanisms of congressional oversight are not everything they need to be, then what are some specific approaches that could strengthen the congressional oversight without threatening the Fed’s ability to conduct monetary policy without political interference?

Andrew: In that sense, my view of the paper was that its goals are pretty modest. And we kind of discuss, in the final portion of the paper— and it's just literally a few pages and one paragraph that talks about [how] the Fed can have a fully independent inspector general. That, to me, actually seems pretty uncontroversial. Every other major government agency has a fully independent IG, including other independent agencies. But I think that part of the reaction to the paper is: don't change anything. The status quo is fine. No changes are needed. No changes are warranted. And so, I'm not sure yet if-- Maybe your podcast will help to actually start a conversation. Is there anything at all that could be done that would help facilitate more appropriate and effective congressional oversight in a democratic society?

Christina: I think in terms of the reactions, it's an interesting question, because I've found that we've gotten different reactions between legal scholars and economists. When legal scholars read this paper, I think it's more intriguing for them. They're not coming from it necessarily with the background of central bank independence that economists are. More specifically, as some of your listeners may or may not know, the Supreme Court is really focused on a lot of issues concerning accountability broadly within the administrative state, and more narrowly, also, with a lot of the financial regulatory agencies.

Christina: And so, this set of questions about some things we don't get into in the paper, and some things we do, but just thinking about how agencies are accountable to the American people through Congress, is something that is top of mind for legal scholars right now. So, I do think they were very interested in seeing this paper. I think that the legal scholars that I've shown this to that are specifically expert in central banking— and a number of them were at this London School of Economics workshop that I presented at— were also really curious and engaged, because this question about, what is the legal framework around central bank balance sheet policy, is really uncharted territory right now, and central banks are trying to figure that out themselves. So, I think that was something that's also really interesting.

Christina: Then, as Andy was alluding to, I think that the economists have reacted to the paper with concern for the maintenance, if you will, of central bank independence. We've tried very hard to communicate the message that we also support central bank independence, but it's about making it square, again, with-- I know we keep repeating this point, but making it square within the four corners of constitutional democracy. And I guess the last thing I will say really quickly, which might also be-- I know you have a number of listeners in the UK. This, in part, answers your question about what has been their reaction and also the motivation for the paper. 

Christina: I testified twice in the House of Lords in the past two years, and what's really striking is that, in the UK, and in the House of Lords Economic Affairs Committee in particular, a big part of both of these inquiries— one was about QE and the other was about the operational independence of the Bank of England— they're very keen to understand what is the appropriate, the correct, the optimal balance between accountability and independence. They're not shying away from this question. They're really trying to ask questions to make sure we get it right, and I think we need that same level of questioning and concern and scrutiny here as well.

David: Alright, well, let's jump into it. And the first part of your paper deals with the constitutional authority that the Fed operates under. Walk us through that section.

The Fed’s Power Under a Constitutional Authority

Christina: Okay, well, as the lawyer on the paper, I'll take that section. So, in this section of the paper, we're not-- Again, this is sort of myth-busting, I guess, about our paper, which, again, is a great service of your podcast. So, thank you for giving us that opportunity. We're not questioning the constitutional authority of the Fed's powers, full stop. We're trying to think about how the central bank's power— how the Fed's power— is operating within the US Constitution, specifically.

Christina: And so, I think, to table set here, it's helpful to explain a little bit about two important constitutional principles, that when taken together, are really making the case for why Congress is constitutionally obligated to, as we say in the paper, “energetically oversee the Fed.” The first principle has to do with the separation of powers, and the second principle has to do with the extent to which Congress can delegate its powers. So, when we talk about the separation of powers, we're really referring to the structure of the Constitution. The US Constitution specifies that there are three branches of government: the legislature, the executive branch, [and] the judiciary. When you think about where the Fed fits in, it's actually, generally, a very difficult question to answer, where the Fed fits into this three-branch system of government that we have.

Christina: Normally, when we talk about administrative agencies, we, being legal scholars [and] constitutional law scholars, conceptualize them as sitting within the executive branch, because they're helping the president “take care” that the laws are executed or implemented right. This comes from the Take Care Clause in the Constitution, and some of these agencies are structured to be more independent of the executive and others aren't. Nevertheless, these agencies are meant to just be filling in the details— to borrow language from Supreme Court precedent— but filling in the details of laws that have been written by Congress.

Christina: Now, this can't really, at all, describe what is going on with the Fed, because in no sense is the Fed really part of the executive branch. The executive branch is not responsible for implementing monetary policy, and, in fact, quite the opposite. We know that the framers and the ratifiers of the Constitution were very specific in keeping these monetary and fiscal powers away from the executive branch. They're clearly legislative powers given to Congress, exclusively. So, if we can't really think about the Fed as part of the executive branch, and the Fed's obviously not the courts, and it's not Congress, [then] we nevertheless have to think about the Fed as very closely connected to Congress, because as Andy said at the beginning, the Fed, legally speaking, constitutionally speaking, cannot be a fourth branch of government. There is no fourth branch of government.

Christina: It doesn't have a separate constitutional status, unlike some other central banks, like the ECB, for example. So, that implies that even though the Fed is a unique agency, it's carrying out duties for Congress, and we'll talk about where those duties are in the Constitution in a second. And so, Congress has to really think about the Fed like its agent, like a fiduciary. So, this brings us to principle number two around delegation. And the short of the matter is that the Constitution also prohibits Congress from giving away any of its legislative powers to another branch, and certainly not to the central bank. So, the Fed is exercising certain legislative duties. There's language in Article I, Section 8 of the Constitution around regulating the value of money. That's typically where we think of the locus of power for monetary policy.

Christina: Article 1, section 9 talks about fiscal authority that's, again, exclusively given to Congress. And so, when the Fed is doing things like borrowing from the public by creating reserves and repos— and I'm sure Andy will get into this in a little bit— [then] the Fed is also exercising Congress's Article 1 power. So, it's exercising these legislative powers and with a very high degree of freedom. So, the Fed is not subject to appropriation like other independent agencies. The Fed governors have very long terms, 14-year terms, so they don't have to worry about reappointment— these political forces that might govern reappointment. And they have “for cause” removal protection, so they don't have to worry about getting fired.

Christina: So, the point is that the Fed is exercising really important duties that belong to Congress in Article 1 of the Constitution and duties which Congress cannot give away. So, because we know that the Fed can't be a fourth branch of government, and because we know that it's exercising Congress's Article 1 power really quite closely and directly to what the Constitution gives to Congress, these two principles taken together really compel Congress to do a robust job when it's overseeing the Fed.

Christina: And so, part 1 of the paper is really making this legal— this constitutional case for why it matters that Congress does a good job overseeing the Fed. We'll get into the policy issues in part two of the paper, but just as that rule of law point— this point about what is appropriate in a constitutional democracy— this is what's appropriate in the United States. Congress has to do a good and energetic job overseeing its agent— its fiduciary— the Federal Reserve.

Andrew: I'll just elaborate a little bit on what Christina was saying on your previous question. Monetary economists are actually familiar with some of this history, because we know that kings and emperors used to value and depreciate currencies all the time, and that that was a big problem. And we understand why the British Parliament insisted that regulating the value of money should be a prerogative of the Parliament and not the king, [and it] was precisely to preserve price stability and avoid political interference.

Andrew: And so, that was what the founders were thinking when they put this very clearly into the Constitution in Article I, was that it's not the executive that regulates the money supply. It's the legislature. It's the Congress that's responsible. In effect, the founders of the Constitution were specifically trying to protect what we would think of in modern terms as monetary policy. They were trying to protect that from political interference from the executive branch.

Andrew: Another thing that's important is that for most other things Christina was talking about that are-- within the executive branch, they're independent. They're insulated. The Federal Trade Commission, other independent agencies, securities laws, those are subject to a traditional review. A company or investor or a consumer or a business that feels like those regulations were unfairly designed or implemented can file a suit in court and have a judicial hearing. And in some cases, the court can decide to overrule the independent agency.

Andrew: With monetary policy, there is no judicial review. There's a very long legal history of this going back close to 100 years now of the Supreme Court and other federal courts saying, "No, we're not going to review the Federal Reserve's monetary policies, their policy decisions. Those inherently need to vary from one day or week or month to the next. They need to be contingent on specific circumstances. It's just not subject to judicial review.” And moreover, the court said, "If people have a problem with the way the Federal Reserve is creating monetary policy, those people should go to Congress," that Congress is the Fed’s [inaudible].

Andrew: So, basically, what you have is this central bank in the United States being completely outside of the judicial branch and outside of judicial review, and for all practical purposes, outside of the executive branch. So, this, again, as Christina said, it creates a very strong imperative for energetic congressional oversight, because there is no other alternative in a democratic society. If there's going to be oversight, it has to be from Congress. 

David: Well, let's move on to the next part of your paper called “Sources of Undersight.” You have three sections: informing Congress, the Fed's balance sheet issues, and then Fed efficiencies. So, Andy, I think you're going to take us with this one. Why don't you start off with informing Congress?

Sources of Undersight: Informing Congress

Andrew: It's kind of remarkable that— well, when the Federal Reserve was created, it didn't have any monetary policy responsibilities, not really. It was basically providing liquidity to banks. But then, when we went off the gold standard in the '30s, and when the Fed and Treasury reached an accord in the early '50s, it became clear that the FOMC, the Federal Open Market Committee, which is the monetary policymaking body of the Fed, really is setting the nation's monetary policy. There wasn't really much in the way of formal mechanisms for the FOMC to explain to Congress about how and why it was doing monetary policy.

Andrew: In the '70s, there was a significant move in, ultimately, what we call the Humphrey-Hawkins Act, to impose some specific reporting requirements. But then, almost all of that was disbanded at the end of the '90s, kind of viewed as no longer necessary, and that was after a period of 10 or 15 years when inflation had been relatively low and stable, and the Fed was no longer very controversial. So, for practical purposes, over the last 20 to 25 years, the Fed can report whatever it wants to Congress, as little or as much as it wants to. And sometimes they add more, and sometimes they take things out. It's somewhat idiosyncratic. And so, I think that there's a question there of whether there's room for improvement in terms of Congress as the Fed’s boss. It's natural for the boss to say, "Here's what I'd like you to report back to me,” to be more specific than the current statutes.

David: You also bring up, in this section, the declining dissent, both among the board members, which I think is well-known— Board members typically now agree with the chair or they vote with the chair. But even the regional bank presidents, I was a little surprised to see that. That's actually gone down as well. That's declined. There's still some dissent there. And then, you also have some great charts illustrating that, but you also provide some statistics on the median tenure of the governors versus the chair. The chair tends to last longer than most governors do. And so, we end up in this world where there's very little dissent. Why have we come to this place where there is little dissent, and, therefore, as it ties into the paper, less information coming to Congress about what the Fed is doing?

Little Dissent, Less Information

Christina: So, this part of the paper has— I think it's fair to say, Andy, would you agree— attracted a lot of attention. People like you note that these trends are really interesting, for lack of a better word. And so, I think the data, and the really compelling charts that Andy put together, have been helpful in shedding light on the lack of dissents. I mean, big picture, ideally, Congress would be able to understand the individual viewpoints of FOMC members, to get a better handle on why certain decisions were made, especially at key inflection points during policymaking.

Christina: And so, in particular, when we're thinking about why there was a decline in dissents from Reserve Bank presidents, we start to also scrutinize changes in certain governance practices and, in particular, the process for appointing Reserve Bank presidents. We know that, historically, the regional Reserve Bank presidents played a very active and important role in dissenting and countering groupthink, if you will, and offering a contrary view, which, historically, a major rationale and purpose of having the regional Reserve Banks was, if you go back to the founding of the Federal Reserve System, Congress wanted to have a diversity of viewpoints and to have the "political views" of the board in Washington countered with the regional views from around the country. 

Christina: And, for most of the Federal Reserve's history, the regional Reserve Banks’ presidents really didn't play that role, but, in recent years, as we document in the paper, you see this decline in dissents that coincides with a larger role for the Board of Governors in the selection of Reserve Bank presidents. So, according to the Federal Reserve Act, the regional banks' private boards of governors are responsible for choosing the regional Fed Bank president. So, there are three classes of directors on a regional Reserve Bank board, and two of those classes are not appointed by the Federal Reserve Board. So, that's another way of just saying that class A and class B directors, comprising the majority of the board, are selected by the private member banks.

Christina: So, in other words, when you have this system operating the way that it was intended to in the Federal Reserve Act, you really don't have the board playing a big role. The Federal Reserve Act does give the Fed the power to veto that choice, but the Fed Board had never used that process and really took a more hands-off approach in the front-end selection of regional Reserve Bank presidents. But in recent years, it looks like, according to the Board's own disclosed practices of how it goes about working with the regional Fed banks to choose the next president, the board has a bigger role.

Christina: It just begs the question of whether the newer crop of regional Fed Bank presidents have viewpoints that are more inherently aligned with the viewpoints of the Board because there's been a closer connection between the Board and the regional Feds and choosing that. And if there is a closer methodological or ideological connection, then, of course, you're less likely to see dissents happen, so we note that trend. Andy, do you want to add on to that?

Andrew: Again, I'm old, so I think that when we were thinking about monetary policy in the '80s, in the early '90s, there was sort of a view that it was an engineering problem, it was a technical problem. And so, when the Reserve Bank of New Zealand moved to inflation targeting, it was a single decision maker, the governor, who could be rewarded or fired depending on how inflation did. So, put one person in charge, make them responsible for it, and they can do it with the right incentives. So, over the course of the '90s and into the 2000s, there was a move toward recognizing that monetary policy is complex and that it's important to do it with a committee. And so, when the Bank of England became independent in the late '90s, they created the MPC. Alan Blinder has written a lot about the importance of having a monetary policy committee in the United States, with the FOMC.

Andrew: Ben Bernanke was a very strong advocate of having a very lively committee discussion, and he was comfortable with dissents. And all of that was consistent with this idea that these are really complex decisions. We're not sure of the right model of how the economy works. We're not sure how much weight to put on different kinds of data or how long our lens should be in terms of what kinds of history we look at and which lessons are relevant from past experience. What are the risks that might be coming and how much weight [do we] put on those risks? So, there's a lot of judgment involved, and so having a diverse committee is really important to making good decisions.

Andrew: And so, I think the challenge here for Congress is that Congress designed it that way, but it doesn't seem like it's working that way anymore. And so, in the last two years there were no dissents— literally, I think the last dissent was almost exactly two years ago. So, what's happening? Is it that the answer to monetary policy prescriptions are so obvious that everyone would agree, or is there something else going on in terms of a mixture, probably, of culture, of changes in structural mechanisms like Christina was describing? And should Congress be concerned or not? At least, at a minimum, you think that Congress would want to inquire into this and understand it.

David: So, why has there been so little dissent?

Andrew: So, my own view about this, which is just one perspective of it, is that there's been gradual changes in the culture inside the Federal Reserve, that consensus is a really good thing, that the consensus means don't rock the boat too much, that it's really good for the markets if the Fed speaks with one voice, that that helps the markets understand more clearly what the Fed is doing and what it's planning to do. And I think there's been a cultural change— subtle, but notable change— that the Federal Reserve Bank presidents are subordinates of the Federal Reserve Board. And so I think that the change in the appointment process that Christina was describing a few minutes ago, the fact that in principle, the Federal Reserve Board could fire a Federal Reserve Bank president, it can be as easy, honestly, as the Fed chair calling the chair of the local board of directors and saying something. It could trigger a process that would end up with a Federal Reserve Bank president leaving. It doesn't have to be a formal firing.

Andrew: The point is that these subtle cultural changes, I think, have led more and more to a sense of, the Fed chair is in charge, and everyone else is, ultimately, trying to support the Fed chair. The Fed chair is the one who's visible [at] the congressional hearings, [at] the press conference. The photographs in the Wall Street Journal and the Washington Post and Financial Times are practically always of the Fed chair. And so the whole rest of the organization is trying to support the Fed chair, and what the Fed Chair thinks ultimately becomes the policy, and then there's no dissents.

David: You also cover, in this section, the sources of undersight, the Fed's balance sheet. And, Andy, we've had you on the show before, had a great discussion there. We'll provide a link to that. But one of the issues that you bring up, both here and earlier in the paper, is that the Fed's liabilities, the Fed's debt, does not get added to the overall debt of the US government. It doesn't get counted towards the statutory limit. And I can think of a scenario where maybe that's not a big deal, if the Fed just buys up Treasuries, no big deal. But when the Fed starts buying up mortgage-backed securities, it literally is adding net new liabilities to the US government. Is that right? Why isn't that counted toward the national debt limit?

Sources of Undersight: The Fed’s Balance Sheet

Andrew: I guess what I would say is that the Fed's expanding its balance sheet, so its assets and its liabilities are expanding. It doesn't actually matter so much whether it's Treasuries or mortgage-backed securities or something else. The Fed is issuing a liability, which would typically be reserves held at the Fed or reverse repos, which are essentially a liability of the Fed and the repo market, and it's got an asset that it's purchased using those liabilities. The problem here is that the liabilities are very, very short-term, overnight liabilities, and the interest on those liabilities is an overnight interest rate, where the assets— and maybe longer-term assets— where the rate of return on those longer-term assets can be completely misaligned with overnight rates.

Andrew: So, in effect, the Fed's balance sheet becomes much, much more complex than it was 20, 30 years ago. At that time, almost all of the Fed's liabilities were paper cash that didn't pay interest, and most of its assets were Treasury securities that were short and medium-term. So, there was no real risk on the Fed's balance sheet. Now what we've seen very vividly in the last couple of years is that the Fed's actions in expanding its balance sheet can have huge costs to taxpayers, because there's now real risks in this misalignment between the assets and liabilities.

David: Right, so, there's added interest rate risk that the Fed has created that wasn't there before, so I acknowledge that. But from a consolidated budget perspective, if the Fed is taking out Treasuries [and] adding reserves, you could argue that it's an offset. There's no net gain in overall government debt. There's no using up of fiscal space, unless it's going and getting something other than Treasuries, like mortgage-backed securities. If I'm concerned about adding to the national debt, what would I really be worried about, the mortgage-backed securities or just the enlargement of the Fed's balance sheet overall?

Andrew: Well, I guess I would say all of the above. I think that the Treasury is responsible for managing the composition of the federal debt, but the Federal Reserve's decisions are outside of that. Even when the Federal Reserve is buying a Treasury and funding it with its own Federal Reserve liabilities, it’s basically moving things out of-- the Treasury reports to Congress. The Treasury Department's appropriations, its positions, are all subject to congressional review. The Federal Reserve, as it is right now, its management of its balance sheet isn't really subject, in any serious way, to review by anyone.

David: No, I agree with that. The Fed is effectively becoming a public debt manager, a role that was delegated to Treasury, not to the Fed. And that's important, because it is altering the maturity of the debt structure, adding interest rate risk, all of those things that should be something that Congress has a say in. Why hasn't this received more discussion? And I know you've been on this trail, you've been hot on it, you've been pursuing it, you've been writing articles, giving talks. Why do you think it's received relatively little attention here compared to overseas? Because, again, at the ECB, they're doing a framework review that's related to this very issue.

Andrew: Well, Christina could comment, I think, because as she said, the UK Parliament is inquiring into these issues, and the UK Parliament has established procedures, and the Treasury Department in the UK has indemnified the Bank of England. So, Christina, do you want to talk for a moment? Because I think you've seen the oversight there in contrast to the US.

Christina: Sure. There does certainly seem to be more interest. I speak to the Bank of England and the UK system more since, as I mentioned before, I was involved in some of the parliamentary inquiries. There does seem to be more legislative questioning about both of the big picture questions of what the more active use of balance sheet policy— a world in which QE and QT are a normal part of the policy toolkit—what this implies for the way that central banks answer questions, both to Parliament, and in the case of the UK, to the Treasury, because the setup in the UK is a little bit different, where the Bank of England is technically accountable to both the Treasury and the Parliament.

Christina: And the loss-bearing arrangement is also different in the UK, where the Treasury, HMT, did indemnify the Bank of England for losses that it suffers on its asset purchase facility. So, that naturally sets up more incentive, potentially, by the Treasury Select Committee and the House of Lords, to ask questions about balance sheet losses. And you're quite right that I haven't, at least, seen that same level of ex post inquiry from Congress to the Fed about, why were certain policy choices made? We bring this up in the paper, why did you decide to buy bonds for as long as you did during QE4, when we had the experience of QE1, 2, and 3 that we could have learned from, and at least learned what questions to ask before the onset of the program? And so, I can't really say why that same level of interest, concern, and scrutiny hasn't happened in the US. But, I think, going back to one of your first questions, this is one of the motivations for writing the paper, is that there's no need to be concerned that there are going to be these terribly adverse consequences to central bank independence from asking these questions.

Christina: It just should be understood as healthy and good governance of central bank balance sheet policy going forward that the legislature is equipped and interested and incentivized to ask these questions like we see in the UK, and as Andy mentioned, in the ECB, and not just with decisions around QE, but also with the monetary policy frameworks and instantiating some regular review procedure as well. I think that all of these things are really important, and so, that's part of what we're trying to do with this paper. 

David: Okay, before we move on to the final section of the paper, one last issue you bring up in this section that's really interesting is how the Fed is recording its losses that it's currently experiencing. It has this deferred asset— it's a unique accounting term that it's created on its own. And you note in the paper that the Fed is effectively borrowing from the public to cover itself as it's going through these losses. Can you explain, how is it that the Fed is borrowing from the public to cover the losses until it gets out of the hole?

Andrew: The how is actually easy. The Fed can issue additional bank reserves and it can engage in additional reverse repos. Think about it, roughly speaking, as a family or a small business that's running a temporary operating loss this year. Well, what they need to do is they need to find an investor or a bank that's willing to lend them the money, or if they're lucky, they can put it on a credit card for a while. And then, the hope is that, at the end of the year, the operating income will switch to positive, and then they'll pay back that credit card that they took out, or they'll pay back that temporary loan from the bank, and get back to business as usual.

Andrew: And so, the Fed has set up an accounting device where it's kind of an IOU to promise to say, “We're borrowing extra right now to cover our operating losses, but before we resume remittances to the Treasury, we're going to pay back that amount.” So, what it really means is that the remittances to the Treasury— which used to be pretty predictable, call it $100 billion a year, that's mostly coming from the fact that the Fed has a lot of paper cash that it doesn't pay interest on. Okay, that gives it a golden goose that earns interest every year, and most of it goes to Treasury. That $100 billion a year is not going to be paid to Treasury until, probably, the end of this decade, or maybe early into the 2030s, because the Fed has operating losses and very low operating income even later this decade, that it's going to take a while to pay back the extra amount that it had to borrow to cover its losses.

David: And you estimate, in your earlier work, that it's going to be, probably, around a trillion dollars when it's all said and done?

Andrew: Yes, more than a trillion.

David: More than a trillion.

Andrew: Probably closer, because at that time that Bill Nelson and I were working on this, people were expecting that, pretty quickly, interest rates were going to go back to around 2.5 or 3%. Now, markets are thinking that the normal level of interest rates is probably closer to 4%. So, the Fed's QE4 program has turned out to be extremely expensive to taxpayers on the order of 5% of GDP, which is a big number.

David: So, I brought up this question of how does it borrow, because I think that many observers, when they hear that the Fed is losing money, they're like, "Oh, okay, no big deal, the Fed's just not sending remittances to the Treasury. In the future it will get its act together." But it needs to be made, this point, that it's actually borrowing, it's actually increasing the debt stock of the government, when it does this. It's not just-- we're not sending remittances to the Treasury, we're actually adding debt. Now, eventually, it will pay it off. Presumably, it will get profitable again in the future, and this won't be an issue, but it's a sizable addition to the debt, correct?

Andrew: Well, we should be clear on two separate questions. One of them is, how much is the Fed going to actually have to borrow from the public? And the answer to that is a few hundred billion dollars, probably, at its peak. It will be a few hundred billion dollars. A separate question is, this balance sheet program that it did [from] 2020 to 2022, how much is that going to cost taxpayers? The right way to answer that question is to compare the remittances that the Fed would have made to the Treasury if they hadn't done that program to what the actual remittances will be over the next 5, 10, 15 years. And the answer to that question is one and a half trillion dollars. It's a much bigger number.

David: Let's move to the final part of your paper, and to motivate it, I want to read an excerpt from your section a little bit earlier where you make a neat comparison to highlight where we are, currently, with the Fed. And you guys note in the paper, "The Fed would not be the first agency in US history to outpace Congress. By now, it is well documented and understood that after World War II, the imperatives of the Cold War motivated the formalization of various intelligence agencies that exercised expansive powers hidden from public view. It was not until the early 1990s that Congress established mechanisms for exercising meaningful oversight of the intelligence community. In a similar fashion, Congress may now wish to revisit its mechanisms for overseeing the Federal Reserve System, given how radically the Fed has changed." Okay, so what are some suggestions? You have several in the paper, so walk us through them.

Proposals for Improving Fed Oversight

Christina: Yes, so, I'm glad you brought this portion of the paper up and read that paragraph. Before we get into the suggestions that we have, I do want to emphasize the power of this analogy. Because I think a lot of people's gut reaction to the paper is that the Fed is special. What it's doing is too complicated. It's too important to muck it up with these pedestrian versions of congressional oversight. And the Fed is also special, because what it's doing is necessarily clandestine in some respects. I think that's a very longstanding sense in central banking history, and I think we can look around and say that we have other prototypes for this.

Christina: It's not impossible to use these tried and true tools of independent oversight, agency oversight, but also make them somewhat bespoke, just to take account of the fact that we have an agency that's doing something incredibly important for the national economy and [that’s] incredibly complex and also needs to have some modicum of secrecy around it. So, I'm really glad that you brought up that analogy, and for people to sort of noodle on that a little bit when they're thinking about the recommendations that we put forward.

Christina: I'm happy to walk through some of them. One is just to think about the role of the GAO. So, as we point out in the paper, for all other major independent agencies, the GAO has an important role in engaging in, among other things, performance reviews; essentially just asking these questions about whether taxpayer funds have been used as efficiently as they could have been. And I think that there's an important shift here in really thinking about the Fed's balance sheet, as we've been talking about for the past hour or so, as a tool of quasi-fiscal policy, or at least recognizing that some of the choices that the Fed makes around QE do have fiscal consequences and do implicate taxpayer funds.

Christina: And so, this should make us revisit the decision long ago to exempt monetary policy decisions from GAO review. And so, one of the things that we're proposing is to bring the Fed's monetary policy choices in line with the choices that are made by other major independent agencies, and have this external review framework in place for thinking through the choices that were made or whether they could have been made more efficiently. And I will note that this is, again, not particularly earth-shattering. The Bank of England has a process for engaging in an external and internal review, as does the IMF, and I'm sure other central banks do as well. Andy, do you want to cover some of the other recommendations we put out there?

Andrew: Well, just to elaborate on what Christina said, I think that my general thought when we were working on the paper was that these proposals for strengthened congressional oversight should be pretty unobjectionable; for example, asking the Fed for some specific reporting requirements, and it's sending of annual reports to Congress. If the Fed decided to change the inflation goal, for example, I think that would be a major decision, and it'd be appropriate for Congress to say, “Before you do that, you need to come to us. We need to have a hearing where you tell us what you're thinking about and why you're thinking about changing it, and give us an opportunity to hear about it and, potentially, to weigh in.”

Andrew: As it is right now, there's been serious discussions among monetary economists about the possibility of the Fed raising the inflation target to three or four percent. Fortunately, I believe, Chair Powell has said, “No, that's out of bounds.” But, conceivably, the Fed could revisit that at some point down the road. And so this is the sort of thing where, by having reporting requirements, it would help ensure that Congress is kept informed, not just after the fact, ex post, but during the considerations, because it's such an important-- Congress gave the Fed a broad mandate, maximum employment and price stability, but I think it's reasonable for-- Again, we said before, and Christina, you should clarify what I said about judicial review.

Andrew: I think that the Fed's decision about its inflation target would probably not be susceptible to review by the Supreme Court. So, if there is any public review in a democracy, it would have to be Congress, and so having these reporting requirements seems, to me, [to be] really important for democratic accountability. The GAO, the fully independent IG thus-- what I wish is that the leaders of the Fed would go to Congress and say, "You know what, we would welcome these mechanisms.” Really good organizations are always looking for ways to improve, that many organizations bring in an outside management consultant to take a look at everything, and come up with some recommendations, and then have to follow them all. But, I think that having the GAO come in and look at the Fed's operating procedures, and the size of its balance sheet, and its decisions about buying MBS or not, would be helpful, and the Fed should welcome it rather than resisting it as some alarming threat to its existence.

Christina: And I do think it's important to clarify the nature of the review that we're talking about, because I think that some people had the reaction that we were suggesting battle plan drafting here. We're not suggesting that the GAO should intervene and tell the Fed exactly how many MBS it should be buying, what proportion of Treasuries it should be buying, in what quantity, and when to stop. We're more so talking about these big-picture operating framework decisions and doing these postmortem, lesson-learning exercises for major monetary policy interventions, but not getting into the heat of battle, which we acknowledge would not be productive or stabilizing for markets either. So, it's one big-picture accountability, not the micromanagement of the Fed, that we're talking about.

Andrew: And, by the way, I'm a big fan of the GAO. I think the GAO has a pretty stellar track record. They aren’t the type micromanage the other independent agencies that they review. They're doing a performance review that's intended to look at the bigger picture questions that are relevant over a longer period. They take substantial time to do it. Sometimes it's a year or two or three to complete a report. It's published, it goes to Congress, [and] it goes to that agency. The agency can agree or disagree, but I think it's a constructive process. And as Christina said, the Bank of England goes through this. Ben Bernanke is there, right now, doing an external review of the Bank of England's forecasting process. Wouldn't it be amazing if the Fed would welcome GAO to come into the Fed and do an external review of the Federal Reserve's forecasting process? Why not?

David: So, one other possible reform, and you guys alluded to this in the paper earlier, is that the IG at the Fed currently reports to the board, reports to the chair, and most other agencies have a truly independent one. So, what are your thoughts about making the Fed's inspector general truly independent and reporting to Congress?

Andrew: So, I think that if the Federal Reserve wants to be well insulated from political interference— and we all agree that's really crucial. I think that you said it yourself, David. A lot of your battles are trying to help preserve central bank independence from political interference. In order to do that, the public does have to have a fundamental degree of confidence in the Fed and the Fed's legitimacy. And so, I think that a lot of what Christina and I are raising here, in this paper—and trying to be constructive, not just criticizing, but trying to come up with some constructive suggestions— is to help reinforce the public confidence that the Federal Reserve is, in fact, thinking really hard about its decisions with a diverse set of inputs.

Andrew: Not just one person, a philosopher king, making decisions and everyone else bows down to those, but, like the Supreme Court, having tough debates where people feel free to disagree, and where they're individually accountable, and where the balance sheet decisions can have huge costs to taxpayers, that the public should have confidence that those decisions are being made carefully over time. And so, having a report to Congress, having GAO reviews, having a fully independent IG, all of these things, I think, ultimately, here, are not just to strengthen the Fed's decisions, [but] they're [also] to strengthen the public confidence in Fed's decisions. And every other agency has these forms of oversight. So, I think the question that Christina raised earlier is, this is pretty much tried and true, some of it, at least. There might be ways to apply it to the Federal Reserve.

David: Now, Christina, I understand that you have an upcoming paper that completes the story, looks at the Fed's regulatory role in banking and finance?

Christina: Yes. Well, spoiler alert, yes. I'm working on a paper for a symposium that's being held by The University of Chicago Law Review on the premise of central bank independence as applied to the central bank's supervision and regulation function, so stay tuned for that. Thanks for the opportunity to advertise in advance, David.

David: Absolutely. Well, with that, our time is up today. Our guests have been Andrew Levin and Christina Skinner. Thank you again, Andy and Christina, for coming on the program.

Christina: Thanks, David.

Andrew: Thank you.