Transparency and the Fed

Washington Post columnist Neil Irwin stopped by to discuss his book, The Alchemists: Three Central Bankers and a World on Fire. It's a great read on the history of central banks, including how they responded to the financial crisis and the challenges they face in the future.

The Fed used to be very insular and secretive, and we still hear cries to "Audit the Fed!" But a lot has changed in recent years, and Neil explains the many ways in which we actually can find out what's going on behind those traditionally closed doors. A full transcript follows the video.

Morgan Housel: There's also a point in your book where you're talking about so many people criticizing the Fed, and that they want the Fed to be audited, but then you point out that the Fed actually is audited, that it has an independent Inspector General in house.

When you hear all the criticisms about the Fed, how much of it is the Fed actually being secretive, versus most people just not really understanding how the Fed works?

Neil Irwin: It's interesting. The whole Ron Paul "Audit the Fed" campaign, that really hit its peak in probably 2010, but a lot of people believe very strongly in this. I'm sure some people watching this believe strongly in that.

There's one thing I think is a little misleading about the entire thing. To say, "Oh, we need to audit the Fed" strongly implies that they're not audited at all. Our businesses get audited. That's what happens. Well, the Fed is audited in a financial sense.

For the reserve banks, they actually have the private independent audit firms, that do Fortune 500 companies, audit their books every year. There's the Government Accountability Office, the GAO, the government agency that goes in and investigates their procedures, how they handle cash, how their security works. Also an IG, as you mentioned, an Inspector General, within the Federal Reserve.

What they don't allow to be audited is their decisions on monetary policy. What they don't want to happen at the Fed is for Congress and the congressional investigative arm of Congress, the GAO, to go in and say, "OK, explain to us everything; how you decided on monetary policy. We're going to second-guess every move you made on raising or lowering interest rates, what you did at the FOMC."

The fear is that, having that kind of formal process of applying pressure would, over time, mean politicians meddling in the money supply and trying to have a bias toward higher inflation, and that's a dangerous thing.

That said, to your point, if you want to second-guess and ask hard questions about monetary policy, you have a lot of tools to work with. If you know how to read them ...

Look, they announce exactly what they did at the end of their meetings, eight times a year. You get the minutes of the meeting three weeks later. They all give speeches. All the people around that table give speeches explaining their rationale, and what they did and why.

Bernanke himself and the other governors go before the Congress many times a year -- Bernanke was there this morning -- to answer those questions. Then five years later, you even get a transcript of what went on in that private room.

I know this is not popular because people view the Fed as a very secretive institution, which it is, but these monetary policy decisions, I think there's actually more transparency around them than people give them credit for.

Morgan: That's all pretty new, right? I think prior to 1994, they really didn't say much of anything that they were doing.

Neil: It's true, yeah. It's funny, I hear stories. I've only been covering the Fed since 2007.

Some of my counterparts who have been doing it for a couple of decades, it used to be if you wanted to know whether the Fed had adjusted the Federal Funds Rate, had raised interest rates by half a point, you had to go into certain money markets and talk to the people trading in those money markets, who could tell you, "Yeah, it looks like there was more buying, so it looks like they probably raised their funds target by 50 basis points."

Now, of course, they announce that in a statement that goes out to the world, along with three or four paragraphs of explanatory text, explaining why they did it and what their rationale was. I think that, "The Fed is insular and secretive and won't tell you what they're doing" ... that was much more true 20 years ago than it is today.