Why We Don't Audit the Fed

For those who are not aware, we have a central bank in the US, which we call the Federal Reserve System. The central bank in any country is primarily charged with regulating currency, the money supply, and interest rates. Our Federal Reserve System (or simply known as “the Fed”) has the specific objective to carryout policies to promote maximum sustainable employment and price stability. That is fancy talk for keeping unemployment low and controlling inflation.

Libertarians like Rand Paul constantly call for auditing the Fed. While it sounds unbelievable that we don’t audit our central bank, you need to step back and consider what is meant by the word audit. First of all, the financial statements of the Fed are audited! An independent accounting firm does sample accounts, make sure the books balance, and make sure proper division of control is in place.

So what does Paul mean when he suggests the Fed isn’t being audited? An audit can be more than simply bookkeeping and internal controls. An audit can also be done on a bank or credit union’s policies. If you have a policy to limit loan-to-value to 75%, then that policy can be checked to make sure your loans are not exceeding 75% of appraised value. But what policies does Paul want to audit?

Paul is not quite clear on what he wants audited, but it is presumed to be the policies of controlling inflation and keeping unemployment low. The challenge is, who other than the Fed is in a position to say whether the Fed is doing a good job with this? The effectiveness of the policies are not clear cut, and they aren’t as easy to check as say, a loan-to-value policy.

The independence of the Fed is of far greater concern. Politicians will always want to see unemployment as low as possible at any cost. A principle you should understand in macroeconomics is unemployment and inflation are inversely related. In other words, it is tough to have very low unemployment without having high inflation. The Fed needs to balance the two opposing forces. If the Fed isn’t left alone to balance the scale, the fear is the politicians will always be pushing down too hard on unemployment, at the cost of hard-to-control inflation in the future.

Furthermore, our entire money supply and economy will then be at the mercy of whichever party is in power. The objective of the Fed would likely be different, depending on whether Democrats or Republicans control significant parts of government. Our fiscal policy is already a mess, because these two parties cannot effectively work together. Could you imagine if our monetary policy and money supply were subjected to the same gridlock and tampering?

While auditing the Fed sounds logical in theory, it is important to keep in mind that it already is audited! The financial statements and internal controls are audited! The suggestion that the Fed is not audited comes from the opinion that the Fed’s actions and behaviors should have greater government oversight. Presently, the Fed can make decisions about interest rates and controlling inflation without Congress looking over their shoulder, and many argue this independence is what makes the Fed a stable and trusted institution.