Central bank autonomy: a lively US debate

I realise that I return to my blog after an unusually long lay-off. I guess my New Year resolution ought to be that I will be more regular hereafter. Let's hope this doesn't go the way of most New Year resolutions.....

I'd like to focus on a lively debate in the US on the role and governance of the Fed. Bernie Sanders, a candidate for the Democratic nomination, kicked off the debate with a strongly worded article in the NYT. Sanders draws attention to the fact that the banking industry is heavily represented on the US Fed and this introduces serious conflicts of interest- monetary policy may be guided by the interests of the financial sector rather than those of the larger economy.

Secondly, he thinks the Fed has an excessive focus on inflation- he wants the Fed to focus on an unemployment rate of 4% as compared to the present 6-6.5%. Thirdly, Sanders would like the Fed to ensure greater lending to small businesses (our priority sector) and he signals that he wants tighter limits on bank exposure to investment banking. He wants the Fed to release full transcripts of meetings within six months and not after five years. Not least, he wants an independent audit of the Fed every year by the Government Accountability Office.

Larry Summers has a spirited response, agreeing with some of the proposals and disagreeing with others. Summers agrees that having bank representatives on the boards of the Fed system is a terrible idea:

Each of the 12 regional Feds has a board of directors that is made up of nine people— three banking representatives, three private sector non-banking representatives and three public interest representatives. The fact that a member of Goldman Sachs’ board at the time of the 2008 crisis was the “public interest” chairman of the New York Fed board is, to put it mildly, indefensible.
More generally, it is not clear why a government institution with vital policy responsibilities should have a role in governance for the private sector. Yes, advice on market conditions and the like is needed but this can be sought from advisory committees. Yes, the Dodd-Frank reforms did clean things up some by removing bankers from the selection process for regional bank presidents and orientating regulatory responsibility towards Washington. But it is hard to imagine an appropriate governance activity for business figures with respect to the Federal Reserve System. Nor is it clear why banks should in any sense be “shareholders” in that system.

This is where the RBI scores. It has strict rules that bar members of the RBI's board of directors from serving on the boards of any commercial bank. It does have industry representatives but these come from the non-financial sector. The RBI also scores in its much greater focus on financial inclusion (partly thanks to the political authority's own focus on this objective).

Summers seems to think that the Fed is already subject to audit. I do not know what form this takes and whether any GAO audit is made public. Here, I have been arguing that the RBI should be subject to management audit by the CAG. We need always to look at internal processes, including HR issues, and not just on outcomes (such as interest rates or licensing of new banks). Additionally, the RBI governor must have interactions with the Standing Committee of parliament attached to the ministry of finance. That would give him an opportunity to explain the rationale for various decisions to the law makers. Releasing full transcripts of meetings - we can decide what an appropriate time lag is- is also a good idea. It would help ensure that board members are not solely preoccupied with downing samosa and cashew nut.

The danger, in the Indian context, is that autonomous institutions (such as the RBI, IITs, IIMs,DRDO, BARC and others) exercise autonomy without due regard for accountability. The beauty of the parliamentary system is that there is, in the ultimate analysis, accountability to the people for outcomes. We need to formalise mechanisms of accountability for all autonomous institutions. Subjecting institutions to management audit- as distinct from audit of accounts - is a good starting point.