WRAPUP 1-Kohn warns Congress on meddling in Fed's affairs

* Fed pushes back hard against political pressure

* Kohn: eroding Fed independence risks U.S. AAA rating

* Kohn says investors may worry Fed monetizing U.S. debt

By Alister Bull

WASHINGTON, July 9 (Reuters) - The U.S. Federal Reserve on Thursday launched a robust defense of its independence and warned that efforts in Congress to put monetary policy under political sway would hurt the economy.

Fed Vice Chairman Donald Kohn said opening up some of the U.S. central bank's most sensitive decisions to political scrutiny could result in higher long-term interest rates and hurt the United States' credit rating.

Testifying before a congressional panel, Kohn sought to beat back a proposed bill that would open the U.S. central bank's policy decisions to audits by a federal watchdog agency. More than half of the members of the U.S. House of Representatives have signed as co-sponsors of the measure.

"Any substantial erosion of the Federal Reserve's monetary independence likely would lead to higher long-term interest rates as investors begin to fear future inflation," Kohn told a House subcommittee.

Kohn's testimony comes as Congress debates President Barack Obama's plan for regulatory reform, which envisions the Fed taking on an expanded role monitoring risks across the entire financial system to help ward off future financial crises.

The proposal has boosted calls for greater accountability at the central bank, which already faces heavy scrutiny from lawmakers troubled by its role in bailing out Wall Street.

Kohn said the administration's plan would not greatly expand the Fed's power, and said it would work hand-in-glove with monetary policy, not compromise it as some critics contend. For highlights from hearing, see [ID:nN09448635]

BACKLASH

Fed officials have had to endure rigorous congressional grillings over their aggressive actions to restore financial calm. Their e-mails have been subpoenaed, recalling past episodes when the central bank came under attack and was forced to yield to the political will.

The proposed bill, put forward by Representative Ron Paul, a Texas Republican and long-standing Fed foe, would expose decisions on monetary policy and emergency lending to audits by the Government Accountability Office.

The GAO is currently prohibited from auditing these areas. Kohn said removing this exclusion would be highly detrimental and could lead investors to worry that politics -- not economics -- would guide the Fed's decisions.

"The Federal Reserve strongly believes that removing the statutory limits on GAO audits of monetary policy matters would be contrary to the public interest by tending to undermine the independence and efficacy of monetary policy," Kohn said.