Fed official defends bank’s independence

Federal Reserve Board Vice Chairman Donald Kohn said any “substantial erosion” of the central bank’s independence in setting interest rates may fuel investor fears of inflation and provoke higher long-term borrowing costs.

The Fed’s ability to act without political interference is at stake as Congress debates how to overhaul financial regulation after the worst credit crisis since the Great Depression. Some lawmakers advocate congressional audits of the central bank, while others are considering subjecting regional Fed presidents, who vote on interest rates, to Senate approval.

“The insulation from short-term political pressures … that the Congress has established for the Federal Reserve has come to be widely emulated around the world,” Mr. Kohn said in testimony at a House Financial Services subcommittee hearing Thursday on Fed independence.

“History provides numerous examples of non-independent central banks being forced to finance large government budget deficits,” Mr. Kohn said. Higher rates may also “further increase the burden of the national debt on current and future generations.”

The vice chairman said the Fed is more transparent than at any time since its creation almost a century ago. He cited steps this year to expand information on the Fed’s Web site, www.federalreserve.gov, about its programs and to start a monthly report to Congress on the central bank’s emergency lending programs.

Many lawmakers oppose an Obama administration proposal to expand the Fed’s powers to oversee the biggest financial companies.

Mr. Kohn told lawmakers that the administration’s proposal is a “natural outgrowth” of the Fed’s current regulatory responsibilities and would complement monetary policy.

Rep. Spencer Bachus of Alabama, the senior Republican on the Financial Services Committee, disagreed. “We particularly object to what we see as allowing the Fed to become a permanent bailout agency,” Mr. Bachus told Mr. Kohn at the hearing. “We believe that if that’s allowed to happen, that they will sacrifice their independence.”

Mr. Bachus and House Republicans are proposing to strip the Fed of supervisory powers and let non-bank financial firms fail in bankruptcy court.