Bernanke's exit

The Fed chairman told Congress how the central bank would unwind its interventions once the recovery picks up (testimony; Monetary Policy Report, see pages 34-37).

The FOMC is confident that it has the necessary tools to withdraw policy accommodation, when such action becomes appropriate, in a smooth and timely manner.

Bernanke describes the techniques. They include paying higher interest on bank reserves to keep the funds locked in, or reducing the volume of reserves by selling debt (in co-operation with the Treasury, in the case of Treasury bills). One way or another, the Fed does have the tools. The key questions are timing and politics. The timing is bound to be difficult, as unemployment stays high even as the economy starts to rebound. Keeping monetary policy too loose for too long is at least part of the reason we got into this mess in the first place. And not many voices were raised in protest against that policy at the time.

Politics worsens that dilemma of course. Will the Fed be allowed to make its own judgement about monetary policy? It doesn't help that Bernanke's term is nearly up: that gives Congress and the administration extra leverage. Congress is unhappy with the way the Fed has conducted itself lately, and is in the mood to change the rules. Wider oversight powers by the Government Accountability Office are being discussed. Bernanke touched on this in his testimony.

The Congress, however, purposefully--and for good reason--excluded from the scope of potential GAO reviews some highly sensitive areas, notably monetary policy deliberations and operations, including open market and discount window operations. In doing so, the Congress carefully balanced the need for public accountability with the strong public policy benefits that flow from maintaining an appropriate degree of independence for the central bank in the making and execution of monetary policy. Financial markets, in particular, likely would see a grant of review authority in these areas to the GAO as a serious weakening of monetary policy independence. Because GAO reviews may be initiated at the request of members of Congress, reviews or the threat of reviews in these areas could be seen as efforts to try to influence monetary policy decisions.

Indeed they could. Having the tools is not enough. Knowing when to use them, and being allowed to, also count. Watch this space.