WORD ON THE STREET: As you know, ever since the financial crisis began, the Federal Reserve has been lauded by some and criticized by others for its bold actions. This comes with the territory of being the nation's central bank. Certainly, much of the criticism stems from an economy that is very difficult for many citizens. And importantly, some of the criticism is deserved – and we at the Fed truly try to learn when we do fall short.
But some of the criticism stems from what I'll call some "common misconceptions" or assumptions about the Fed. I would like to offer a plainspoken defense to some of those common misconceptions. It is a defense rooted in facts and numbers, to be sure – my rhetorical skills may not win over Fed critics, but the facts and numbers may help them and others understand how the Fed actually operates.
The extraordinary steps the Fed has taken over the last four years have led to some misconceptions and mistaken assumptions. Central banking and monetary policy are not easy to explain, but the Fed could have done a better job of it. But, at the end of the day, we've seen the creation of certain misconceptions, not supported by facts, about the U.S. central bank as an institution. The best way to address a misconception is to offer up the facts.
Common misconception 1: The Federal Reserve is not audited, and its actions occur without oversight.
In recent years, there have been those advocating that the Federal Reserve should be audited. They are right in that the Fed should be audited – but they are mistaken in believing that the Fed is not. In truth, the Fed is a heavily audited organization subject to substantial oversight. This is entirely appropriate, given the sensitivity of what central banks do, and the need to do it without reproach.
In truth, all 12 Federal Reserve Banks employ professional internal auditors. An outside audit firm (Deloitte & Touche) audits our financial statements; the Federal Reserve's Inspector General, created by Congress, audits our activities; the U.S. Government Accountability Office (GAO) audits our actions; and Congress, which created the Federal Reserve System, provides significant oversight regarding Fed actions, as demonstrated by frequent requests to testify before committees, and. by legislation over the years that has altered our role.
But as one who loves data and facts, let me say a bit more to be quite specific on this matter. We produce an annual report that includes audited financial statements and a letter from me as CEO attesting to effective internal controls, based on the work of our internal audit and risk-management teams. We include a letter from Deloitte & Touche attesting that we have maintained, in all material respects, effective internal control over financial reporting.
We are also audited by the Office of Inspector General (OIG), created by Congress to provide independent oversight over the Federal Reserve – with the power to do investigations, inspections, audits and reports. The OIG reports to Congress semiannually – the most recent report covers activities through March and is available on the Web.
We are also audited by the GAO, which conducts audits, investigations, inspections and reports on behalf of Congress. These reports are publicly available on the GAO website.
As with the OIG reports, one GAO report covers the operations of the Fed's emergency liquidity facilities, including the one run at the Boston Fed on behalf of the Federal Reserve System.
And we have direct oversight by Congress, which requests testimony on a wide range of topics. Naturally, congressional hearings include extensive questioning concerning our actions and policies.
We are an entity created by Congress. Congress can and does change our roles and responsibilities over time. A good example is the Dodd-Frank Act, which increased our responsibilities in some areas (e.g., savings and loan holding company supervision) and curtailed our role in others (such as lending in "emergency and exigent" circumstances).
Common misconception 2: The Federal Reserve is not a transparent organization.
When I first joined the Federal Reserve 25 years ago, the lack of transparency was a very valid criticism of the Fed and most other central banks. However, the fact is that much has changed over the last 25 years – and particularly in recent years.
Let me admit that in the midst of the financial crisis in fall 2008, one could fairly say that we did not spend sufficient time explaining to the public the unique and extraordinary actions being taken. All I can say is that in the midst of the crisis, there was a focus on solutions, and given the severity of the situation, this resulted in our spending less time communicating well about what we were doing and why.
Though no excuse, reacting to a crisis in real time effectively requires something else "give" – and we were, frankly, so preoccupied with extinguishing the fire that we did not explain as well as we should have what we were doing and why. At the Fed, we have tried since to explain precisely what we did and why, but we are still some distance from being understood, or fully trusted, for that matter.
I think the Fed has learned from this. I would argue that, at this point, our organization has shifted a great deal compared to two years ago, and at this point, we are quite transparent and getting better at it in time.
The Federal Reserve has also been communicating more directly with the public. The chairman has participated in a variety of what for central bankers are less traditional opportunities, from "60 Minutes" to various town-hall-style meetings, including one last week with soldiers and their families on base in Texas.
The role of the Reserve Bank presidents has also evolved. The text and slides of this speech are available to anyone on our public website. When we can, we make video summaries available as well. We tweet some of the main points. I also give a variety of informal talks that generally provide condensed versions of some of my previous public speeches, and I have, from time to time, had interviews with members of the media working in print, radio and TV.
I am not alone in this respect. My peers have similarly been trying to communicate more about actions we are taking on a range of issues, from monetary policy to supervisory policy to financial stability. We do not always agree on policy matters, and this, in itself, is an indicator of transparency. The fact is that we are quite an open central bank – much better than we used to be – and are improving in this area even as we speak.
Common misconception 3: "Printing money" has caused serious inflation.
In the wake of the failure of Lehman Brothers and the freezing up of short-term credit markets, the Federal Reserve established a variety of emergency liquidity facilities. Something that is frequently overlooked is that over time, all the loans were paid back with interest and the facilities have been closed. The size of the Fed's balance sheet has l continued to grow as a result of our large-scale purchases of Treasury and mortgage-backed securities – policy actions we took given the weak economy and our primary policy rate hitting the lower bound of near zero.
However, while the most rapid growth in reserves occurred three years ago, over the three-year period ending last quarter, the U.S. has experienced the lowest average inflation rate of any such period over the past 30 years. Over the past three years, total personal consumption expenditures (PCE) inflation has averaged only 1.2%. In only two of the five most recent three-year periods has total PCE inflation been above 2% – and these two periods were ones where food and energy shocks occurred.
We have, indeed, expanded our balance sheet – some call that "printing money" – but it is a misconception that it has resulted in significant inflation.
In the recent period, banks have become more risk averse, and have focused (appropriately) on rebuilding their capital – while many borrowers have had their borrowing capacity weakened by the difficult business conditions of a severe recession and slow recovery. The end result is curtailed lending. Bank reserves are not going to be inflationary when bank lending is not expanding.
Let me be quick to stress that inflation would be serious and detrimental at higher levels. I am not suggesting otherwise. I am just pointing out some facts that suggest it is currently very restrained.
Common misconception 4: Rates are already low, so further monetary policy actions will have no impact on the economy.
The empirical evidence shows that Fed purchases of Treasury and mortgage-backed securities did cause market interest rates to fall. While rates can be impacted by a variety of factors, 10-year rates now are much lower than they were before we undertook our actions.
It is unlikely that lower rates would have no impact on the economy. Such an assumption would be quite a leap of faith, because in general further lowering rates would have an impact on home purchases, consumer durables like cars, investment, exchange rates and foreign trade, and impact inflation expectations.
Researchers at the Boston Fed have conducted statistical tests to determine if the reaction to long-term interest rates is different after the crisis, and whether there is empirical evidence that lower interest rates would indeed have no impact. Research by my colleague, Giovanni Olivei, has found that prior to the crisis, our statistical model of the economy would imply that a sustained decline in the 10-year Treasury rate of 100 basis points (bps) would lead to a cumulative increase in real GDP over two years of approximately 2.5%.
With the reduction in interest sensitivity in housing more recently, the model would imply that a sustained decline in the 10-year Treasury rate of 100 bps would now lead to a cumulative increase in real GDP over two years of approximately 2%. Concerns with falling prices, high unemployment and limited access to credit have likely all contributed to this lower – but clearly non-zero – response to lower rates in housing markets. The assertion that our rate actions simply will have no impact is not supported by our statistical work.
Eric S. Rosengren is president and CEO of the Federal Reserve Bank of Boston. This article is adapted and edited from a recent speech delivered at the Boston Economic Club. The full text is available online.
