(Adds more Kohn remarks, background)
By Alister Bull
WASHINGTON, July 9 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. Kohn was speaking before
a Congressional panel where he was seeking to beat back a
proposal that would open policy decisions by the U.S. central
bank to audits by a federal watchdog agency.
"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," he said in
testimony prepared for delivery to a House of Representatives
Financial Services 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 increased calls for greater accountability
at the central bank, which was already facing heavy scrutiny
from lawmakers angered by its role in bailing out Wall Street.
Public anger over last year's financial crisis and
Fed-backed bailouts of investment bank Bear Stearns and insurer
American International Group has created a popular backlash
that could gain momentum in Congress.
A bill put forward by Representative Ron Paul, a Texas
Republican, would expose the Fed's decisions on monetary policy
and emergency lending to audits by the Government
Accountability Office. It has won support from a majority in
the House of Representatives.
The GAO is currently prohibited from auditing these areas.
Kohn said removing this exclusion would be highly detrimental
and could lead investors to worry 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," he said.
He also said it could "cast a chill" on monetary policy
deliberations by making officials nervous ideas they throw
around behind closed doors could become public.
Paul's bill has 250 co-sponsors, including 78 Democrats.
But it has not been promoted by the Democratic majority
leadership in the House, where it has yet to face even a
If it were to emerge from the House, to become law it would
also need to clear the Senate, where support may be more
Kohn warned that congressional meddling in the Fed's
affairs could exact a high cost.
"The bond rating agencies view operational independence of
a country's central bank as an important factor in determining
sovereign credit ratings, suggesting that a threat to the
Federal Reserve's independence could lower the Treasury's debt
rating and thus raise its cost of borrowing," he said.
He made plain the Fed saw Paul's bill as a direct challenge
to its independence that could raise the risk investors might
begin to expect the U.S. central bank to start printing money
to help the government finance a growing budget gap.
"History provides numerous examples of non-independent
central banks being forced to finance large government budget
deficits. Such episodes invariably lead to high inflation," he
said. "Given the current outlook for large federal budget
deficits in the United States, this consideration is especially
Some investors are already worried that a new Fed program
to buy longer-term U.S. Treasury securities has opened the door
to a "monetization" of the debt.
The Fed rejects this view, but is clearly worried this
impression could take firmer root among investors if Congress
extends its influence over monetary policy.
(Additional reporting by Emily Kaiser; Editing by Chizu