The Fed's independence from the public process *updated

As someone who works in financial regulatory compliance, I regularly hear about various types of risk- credit risk, reputation risk, liquidity risk, etc. Recently however, one type of risk has been consuming a lot of time and energy in the banking world- that of interest rate risk. Interest rate risk is simply what might happen to the balance sheet of a depository institution should its cost of short term funding rise as a result of deliberate policy decisions from the FOMC.  Policy and compliance staff at DIs have been spending time developing strategies to mitigate interest rate risk, which usually involves some combination of limiting fixed rate lending, and hedging with plain-vanilla derivative investments. 

Most of the MMT community seems to agree that there is nothing wrong with our current zero interest  rate environment, and that it should be made permanent--so from our point of view all this IR risk mitigation is a waste of time, since the Fed should just leave rates at zero forever and control credit growth by regulating underwriting and capital standards. 

I would argue that changes in monetary policy are just as, if not more, intrusive and burdensome to financial institutions as other types of central bank action. During the traditional rulemaking process, there is (quite appropriately) long periods of agency research, thought, and regulatory development, with opportunities for public comment along the way.

However when it comes to monetary policy, these ideas don't seem to apply. Instead, it is taken as a given that the FOMC-

1) Has all the information in needs

2) Knows what it is doing

3) Can just do whatever it wants

4) Can ignore public input

5) Can safely ignore the “full-employment” part of its dual mandate

All of the financial and economic media/punditry takes all these factors as a given and never challenges them. The FOMC is given an astounding amount of deference and goodwill, despite the increasing evidence (from  minutes and transcripts) that it cant come to a consensus on what is going on in the economy or what its decisions actually do. 

As a political matter, legislators and pundits frequently make comments about “oppressive regulations”, “red tape” and “out of touch bureaucrats” when discussing regulatory agencies. However when it comes to the FOMC, which is one of the least accountable organizations of the federal government, and whose decisions have broad consequences for the banking system and labor market, none of these terms are ever used (BTW, courts have also ruled that the FOMC can't be FOIA'd). People just seem to let the FOMC do whatever it wants, as if it were a mystical tribe of holy oracles, whose intelligence is just to stunning for us lowly commoners to comprehend. 

So even more scandalous, in my view, is that the standard rulemaking procedures established under the Administrative Procedures Act do not seem to apply to FOMC decisions to change interest rates. The primary mode of changing interest rates is the federal funds target rate, which is voted on by the FOMC and carried out by the Federal Reserve Bank of New York. This particular action does not involve amending existing regulations, so I can see how at least this part could escape public input. 

However, open market operations are no longer the Fed's main tool. With the banking system now holding trillions in excess reserves as the result of 3 rounds of QE, the Fed cannot easily change interest rates through open market operations as in the past. It has also indicated that it does not want to rapidly shrink its portfolio. So instead, the Fed can change the rate it pays on required and excess reserve balances, which serves as a floor to interest rates. Thankfully, the rates paid on required and excess reserves are set by regulation and codified in the Code of Federal Regulations.  CFR section §204.10, "Payment of interest on balances" is where the Fed established the rates it pays on reserves. It has been changed only once since the interest on reserves program was established in late 2008. 

The Fed also loans out reserves directly through its discount windows, the rates of which are also set in regulation (smaller amounts of intra-day liquidity are also provided through daylight overdrafts which have similar costs to DW lending, however post-QE with trillions in excess reserves, the volume of overdrafts has plummeted to near zero). 

Section §201.51 of the Federal Reserve Board’s Regulation A is “Interest rates applicable to credit extended by a Federal Reserve Bank.” This section of the US Code of Regulations (CFR) establishes the rates that Federal Reserve Banks must charge to institutions that borrow reserves through the Primary Credit Facility and others. This borrowing price is one of Fed’s tools in implementing monetary policy. As a matter of policy, the Fed usually keeps these discount window rates slightly above its targeted federal funds rate, so every time the FFR target is changed, the discount window rates  are adjusted accordingly.

Therefore, it would seem that in order to change these rates, the Fed would have to initiate the rulemaking process, since amending regulatory text always requires this process. However, as I have recently realized, the Fed does NOT have to follow APA procedures when amending the interest rates it pays on reserves or charges from the window.  Each time the Fed amends Regulations A or D to change these rates, it does use a rulemaking. However, unlike other agency rulemakings, the Fed simply releases these changes as final rules, skipping the public notice-and-comment stage altogether. This loophole completely robs the public of any chance to comment or lobby on the potential effects of such an interest rate change.  

For example, each of these rules are published as final in the Federal Register, and each states near the end-

Administrative Procedure Act

    The Board did not follow the provisions of 5 U.S.C. 553(b) relating to notice and public participation in connection with the adoption of these amendments because the Board for good cause determined that delaying implementation of the new primary and secondary credit rates in order to allow notice and public comment would be unnecessary and contrary to the public interest in fostering price stability and sustainable economic growth. For these same reasons, the Board also has not provided 30 days prior notice of the effective date of the rule under section 553(d).

(Here's an example) 

The crucial text here is “The Board for good cause determined that delaying implementation….in order to allow notice and public comment would be unnecessary and contrary to the public interest.” This is quite an astounding statement that no other regulatory agency could possibly get away with. If the EPA, for example, simply decided that allowing public comment on a Clean Air Act regulation “would be unnecessary and contrary to the public interest”, it would raise an unbelievable shitstorm from both chambers and aisles of Congress.  

As any federal regulator will tell you, public notice-and-comment consumes an large amount of agency time and resources and is a crucial step in developing policy. Some of the reasons for this are good ("the public" should have input into how its country is run), while some are bad (when it comes to influencing regulations, "the public" usually means wealthy corporate lobbyists). 

So lets get some perspective here. How is it that the Fed doing something significant-- changing one of the main "prices of money"-- constitutes “good cause” to ignore the APA, but the EPA, for example, taking actions to save our air, water, food, and climate  does not? I would argue that the EPA has just as important of a role in determining our quality of life as the Fed, and rightfully must follow the public notice-and-comment process set forth in the APA. Somehow the Fed does not. 

This loophole should be the focus of any Fed reform efforts in the 115th Congress. Like it or not, the FOMC still has significant influence over the economic affairs of our country. So instead of trying to "audit the Fed" or change its structure, large strides could be made by simply forcing the Fed to take public comments on its important monetary policy actions. This would give labor groups and progressive economic think tanks a chance to make their ideas and opinions known to the otherwise cloistered FOMC. While I hope the day never comes, if the Fed does eventually decide to raise interest rates, it should hear from We the People first.