Federal Reserve: Legislation in the 115th Congress
Released: 2018-09-25T00:00:00

Introduction

The Federal Reserve's (Fed's) responsibilities as the nation's central bank fall into four main categories: (1) monetary policy, (2) provision of emergency liquidity through the lender of last resort function, (3) supervision of certain types of banks and other financial firms for safety and soundness, and (4) provision of payment system services to financial firms and the government.

The 115 th Congress is considering a number of bills that would affect the Fed's monetary policy, lender of last resort, and regulatory responsibilities. Although these bills contain numerous wide-ranging changes, most provisions can be grouped into five broad categories:

Fed g overnance. Some proposals would change the Fed's institutional structure—how officials are selected, how policy decisions are reached, and so on. O versight and disclosure. Some proposals aim to make the Fed more accountable to Congress by increasing congressional oversight or requiring the Fed to disclose more information to Congress and the public. P olicy rules ( e. g. , the Taylor Rule ) . Some proposals would require the Fed to compare its monetary policy decisions to those prescribed by a policy rule such as the Taylor Rule and report those findings to Congress. T he Fed's emergency lending powers. Some proposals would reduce the Fed's discretion to provide emergency assistance under Section 13(3) of the Federal Reserve Act. The Fed's balance sheet. Some proposals would alter the types of assets that the Fed is allowed to purchase and hold on its balance sheet.

This report analyzes these provisions and the policy debate surrounding them. It does not cover legislation that would change Fed-administered regulation of depository institutions, systemically important financial institutions, and financial market utilities.

Legislative Activity

The following bills affecting the Federal Reserve have seen committee or floor action in the 115 th Congress:

The Financial CHOICE Act ( H.R. 10 ) passed the House on June 8, 2017. Provisions from H.R. 10 were subsequently spun off into identical or similar stand-alone bills ( H.R. 4753 , H.R. 4791 , H.R. 4758 , H.R. 4755 , H.R. 4756 , H.R. 4759 ) that were the subject of a House Financial Services Committee legislative hearing on January 10, 2018. The Federal Reserve Supervision Testimony Clarification Act ( H.R. 4753 ) and the FOMC Policy Responsibility Act ( H.R. 4758 ) were ordered to be reported by the House Financial Services Committee on September 13, 2018. Parts of the Financial CHOICE Act, including a provision that would place the Fed's nonmonetary policy functions under appropriations, were included in the FY2018 Financial Services and General Government Appropriations Act ( H.R. 3280 ), as reported by the Appropriations Committee on July 18, 2017, and an FY2018 omnibus appropriations act ( H.R. 3354 ), as passed by the House on September 14, 2017. These provisions were not included in the FY2018 appropriations act that became law. The Monetary Policy Transparency and Accountability Act ( H.R. 4270 ), the Independence from Credit Policy Act ( H.R. 4278 ), and the Congressional Accountability for Emergency Lending Programs Act ( H.R. 4302 ) were ordered to be reported by the House Financial Services Committee on November 14, 2017. The Fully Informed District Bank Act ( H.R. 4757 ) was the subject of a legislative hearing by the House Financial Services Committee on January 10, 2018. Multiple stand-alone bills from the bullets above ( H.R. 4270 , H.R. 4278 , H.R. 4302 , H.R. 4758 , H.R. 4759 , H.R. 4755 , H.R. 4757 , H.R. 4756 , H.R. 4791 , and H.R. 4753 ) were combined into the Federal Reserve Reform Act ( H.R. 6741 ). It was amended and ordered to be reported by the House Financial Services Committee on September 13, 2018. The Federal Reserve Transparency Act ( H.R. 24 ) was ordered to be reported by the House Oversight and Government Reform Committee on March 28, 2017. Reducing the Fed's surplus has been a commonly proposed budgetary offset ("pay for") in the 115 th Congress, although the FY2018 budget resolution ( H.Con.Res. 71 , agreed to on October 26, 2017) disallowed its use as an offset in the House. The Bipartisan Budget Act ( H.R. 1892 , signed into law on February 9, 2018, as P.L. 115-123 ) included a provision (Section 30205) that reduced the Fed's surplus. The Economic Growth, Regulatory Relief, and Consumer Protection Act ( P.L. 115-174 ), which became law May 24, 2018, further reduced it. Other bills that would reduce the surplus include H.R. 1116 (which passed the House on March 14, 2018), H.R. 4296 (which passed the House on February 27, 2018), H.R. 4607 (which passed the House on March 6, 2018), H.R. 4545 (which passed the House on March 15, 2018), H.R. 4293 (which passed the House on April 11, 2018), and H.R. 4061 (which passed the House on April 11, 2018).

Governance Proposals

Background

The Federal Reserve Act (12 U.S.C. §§221 et seq.) created the Fed as the nation's central bank in 1913. The basic governance structure is largely unchanged in recent decades. The Fed is composed of 12 regional Federal Reserve banks overseen by a Board of Governors in Washington, DC. The board comprises seven governors nominated by the President and confirmed by the Senate. The President selects (and the Senate confirms) a chair and two vice chairs for the Board from among the governors. The governors serve nonrenewable 14-year terms, but the chair and vice chairs serve renewable 4-year terms. Board members are chosen without regard to political affiliation.

In general, the board formulates policy and the regional banks carry it out. Monetary policy decisions, however, are made by the Federal Open Market Committee (FOMC), which is composed of the seven governors, the president of the Federal Reserve Bank of New York, and four other regional bank presidents. The chair of the Board is also the chair of the FOMC. Representation for these 4 seats rotates among the other 11 regional banks. Thus, the governors have more votes on the FOMC than the regional bank presidents when all board positions are filled; however, the board has experienced frequent vacancies in recent years. The FOMC meets at least every six weeks to set monetary policy.

Aside from its permanent seat on the FOMC, the New York Fed has no special role in the Federal Reserve Act compared with other Fed regional banks. Nevertheless, it has taken on certain prominent roles within the system. It carries out the open market operations that implement the FOMC's monetary policy decisions. During the financial crisis, the New York Fed ran many of the Fed's emergency programs (discussed in the " Emergency Lending " section below). It supervises many of the largest banks because they are headquartered in the New York Fed's district. The New York Fed is responsible for conducting foreign exchange transactions on behalf of the government and storing the gold of foreign central banks and international agencies. In all of these instances, it is executing, not formulating, policy. By tradition, the FOMC elects the New York Fed president to be vice chair of the FOMC, a position with no formal powers.

The Fed's capital comprises paid-in capital issued to member banks and retained earnings deposited in its surplus account. P.L. 114-94 included a provision that capped the Fed's surplus at $10 billion. Private banks regulated by the Fed buy stock in the Fed to become member banks. Membership is mandatory for national banks, but optional for state banks. To finance the creation of the Fed, the Federal Reserve Act required member banks to purchase Fed-issued stock. Member banks are required to purchase ("pay in") stock equal to 3% of their capital, and the Fed has the option to call in an additional 3%. The stock can be thought of as a risk-free investment; it pays fixed dividends of 6% for banks with less than $10 billion in assets. Ownership of stock in the Fed confers more limited rights than common stock in a private corporation. For example, stockholders have no control over Fed policy.

Stockholders choose two-thirds of the board of directors at the regional Fed banks, however. Each regional Fed bank has a board that is composed of three Class A directors, required to be representatives of the banking industry chosen by member banks; three Class B directors, representatives of the public chosen by member banks; and three Class C directors, representatives of the public chosen by the Board of Governors. A chairman and deputy chairman of the board are selected from among the Class C directors. The other main difference between the classes of directors is their role in choosing the regional bank presidents. Regional bank presidents are chosen by the Class B and C directors of their boards—not by the President—and must be approved by the Board of Governors.

Analysis

Two debates about the Fed's governance structure have to do with the relative power of various actors within the Federal Reserve System. The first is about the relative voting weight of regional bank presidents vis-à-vis the Board of Governors on the FOMC. The second is about the role of the private member banks.

FOMC Composition. The Board of Governors is responsible for setting policy in most areas, but a key exception is monetary policy, which is set by the FOMC. Currently, responsibility for monetary policy is shared on the FOMC between the Board and the regional bank presidents, with the former receiving seven votes and the latter receiving five votes. Further, because the Fed presidents rotate on the FOMC, certain regional banks have no FOMC representation one of every two or two of every three years, with the exception of the New York Fed.

Some view regional bank presidents as more "hawkish" on inflation than governors, implying that increasing their voting power on the FOMC would lead to a more hawkish monetary policy. This view should be caveated by a number of considerations. First, the FOMC is statutorily mandated to pursue low inflation and has unanimously adopted a 2% inflation target. Second, most FOMC decisions are unanimous or have at most one or two dissents. Dissents, since the 1990s, are much more likely to be lodged by presidents than governors, but a dissent can be made on dovish or hawkish grounds. Third, governors are nominated by the President, and to the extent that governors reflect the President's view, it would be expected that more hawkish Presidents select more hawkish governors, and vice versa. Thus, the relative hawkishness of regional bank presidents compared with governors would not be static over time. Fourth, regional Fed presidents do not vote as a block; instead, each president's voting pattern is highly individual. Recently, all dissents have been lodged by the same few regional bank presidents (some as hawks and some as doves), and many regional bank presidents never dissent. Thus, an effort to tilt monetary policy to a more (or less) hawkish stance would succeed only if the inflationary views of regional bank presidents could be accurately identified before they were selected. Finally, the fact that the Fed chair has not lost an FOMC vote since the 1930s—or come close to losing since 1983 —suggests that the chair either dominates decisions or successfully forges a consensus among FOMC members. Neither scenario supports the view that a change in the FOMC's composition would change monetary policy more than marginally. (It might reduce the chair's influence, since governors have dissented less frequently than presidents in recent decades.)

For these reasons, changing the voting balance on the FOMC may have greater governance implications than economic implications—particularly because inflation has been below 4% for the year in each year since 1991. Namely, a change would affect how centralized monetary policymaking would be, with some researchers finding that regional banks presidents base their votes more on local than national economic conditions. It would also affect—for better or worse —how democratically accountable the FOMC would be, in the sense that the governors are nominated by the President and confirmed by the Senate, whereas the regional bank presidents are selected by regional bank board members (subject to approval by the Board of Governors). Thus, some observers have questioned whether the bank presidents are less partisan or more aligned with banking industry views in their voting patterns, for reasons discussed in the next section.

Role of Private Banks. Private banks that are members of the Federal Reserve system are regulated by the Fed and are required to own shares in the Fed. This raises the question of what rights that ownership stake should confer given the inherent conflict of interest posed by a regulator being owned by the entities it regulates. In addition, policies that limit the banking industry's relationship with the Fed limit the Fed's ability to take advantage of the industry's expertise on the Fed's various other responsibilities.

Ownership of stock in the Fed confers more limited rights than common stock in a private corporation. For example, owners have no control over Fed policy. But member banks choose six of the nine directors on each regional Fed's board, three of whom are required to be from the banking industry (i.e., Class A directors). Membership also gives banks opportunities to advise the Fed through fora such as the Fed's Federal Advisory Council. Other policies are in place to minimize the conflict of interest. For example, Class A directors do not participate in budget or personnel decisions.

The Dodd-Frank Wall Street Reform and Consumer Protection Act ( P.L. 111-203 ) stripped Class A directors of their vote to select their Fed regional bank's president and first vice president. This further limited the conflict of interest posed by private bank ownership of the Fed, but reduced the member banks' rights as owners.

Policy Proposals

Voting on the FOMC. H.R. 10 would change the FOMC's voting membership to increase the number of regional bank presidents from five to six and allow them each to vote every other year. To accomplish this, it would reduce the frequency of the New York Fed's voting rights from every year to every other year and increase the frequency of voting rights for 9 of the other 11 banks from every third year to every other year. H.R. 4759 and H.R. 6741 would give each regional bank president a vote on the FOMC, changing the balance of governor-to-president votes from 7 to 5 to 7 to 12.

Reserve Bank Selection Process. H.R. 4757 and H.R. 6741 would grant Class A directors of each Reserve bank's board (representatives of the banking industry) a vote on the appointments of Fed regional bank presidents and first vice presidents. Currently, only Class B directors (representatives of the public chosen by member banks) and Class C directors (representatives of the public chosen by the Board of Governors) may vote on such appointments. The voting rights of Class A directors were repealed by the Dodd-Frank Act.

Interest Paid on Reserves. H.R. 10 , H.R. 4758 , and H.R. 6741 would shift responsibility for setting the interest rate paid to banks on reserves from the Board of Governors to the FOMC. Congress granted the Fed the authority to pay interest on reserves in 2008 ( P.L. 110-343 ). The Fed uses this interest rate to help it achieve its federal funds rate target, which is set by the FOMC, in the presence of the Fed's large balance sheet.

Staff for Governo rs. H.R. 10 would allow each board member to hire at least two personal staff. Currently, the board and its governors share professional staff.

Congressional Commission. H.R. 10 would create a commission whose voting members are composed of four Members of the House from the majority party, two Members of the House from the minority party, four Members of the Senate from the majority party, and two Members of the Senate from the minority party. The commission would examine and make recommendations on monetary policy, the dual mandate, macroprudential regulation, and lender of last resort functions. The commission is authorized to be funded through congressional appropriations.

Conflict of Interest. H.R. 10 would add ethics standards and conflict of interest rules on investments, outside employment, and outside publications for board governors and staff. Fed employees are currently subject to government-wide conflict of interest standards (18 U.S.C. 208) and employees of the Board of Governors are subject to ethics standards (5 C.F.R. 6801).

Reduction of Fed Surplus. The FY2018 Budget Resolution ( H.Con.Res. 71 ) prohibits reductions in the Fed's surplus from being used as budgetary offsets for "purposes of enforcing the Congressional Budget Act of 1974, this concurrent resolution, or clause 10 of rule XXI of the Rules of the House of Representatives." Nevertheless, Section 30205 of the Bipartisan Budget Act of 2018 ( P.L. 115-123 ) included a provision that reduced the Fed's surplus (composed of retained earnings) from $10 billion to $7.5 billion and required funds in excess of that amount to be remitted to Treasury as general revenues. CBO estimated that this provision will increase revenues by $1.75 billion on net over 10 years. CBO assumed that the Fed will finance the transfer by selling Treasury securities, which otherwise would have earned $0.7 billion in income that would have been remitted to the Treasury in the next 10 years. Thus, the provision can be thought of as shifting Fed remittances from the future to the present, as opposed to representing new economic resources available to the federal government. Similarly, the Economic Growth, Regulatory Relief, and Consumer Protection Act ( P.L. 115-174 ) reduced the surplus from $7.5 billion to $6.825 billion.

Other bills that would reduce the Fed's surplus include H.R. 1116 , which would reduce it from $7.5 billion to $7.39 billion; H.R. 4545 , which would reduce it from $7.5 billion to $7.324 billion; H.R. 4296 , which would reduce the surplus from $7.5 billion to $7.47 billion; and H.R. 4607 , which would reduce the surplus from $7.5 billion to $7.496 billion.

Oversight and Disclosure Proposals

Background

Critics of the Federal Reserve have long argued for more congressional oversight, Fed transparency, and Fed disclosure. Criticism intensified following the extensive assistance that the Fed provided during the financial crisis.

Some critics have downplayed the degree of oversight and disclosure that already takes place. For congressional oversight, since 1978, the Fed has been statutorily required to report to and testify before the House and Senate committees of jurisdiction semiannually. At these hearings, which take place in February and July, the Fed chairman presents the Fed's Monetary Policy Report to the Congress , testifies, and responds to questions from committee members. In addition, these committees periodically hold more focused hearings on Fed topics. On January 25, 2012, the Fed began publishing forecasts for its federal funds rate target and announced a longer-run goal of 2% for inflation. According to the Fed, it hopes greater transparency about its intentions will strengthen financial market participants' understanding of its actions, thereby making those actions more effective.

Contrary to popular belief, the Government Accountability Office (GAO) has conducted audits of the Fed's regulatory and payment activities regularly since 1978, subject to statutory restrictions. In addition, private-sector auditors audit the Fed's financial statements and the Fed has an Office of Inspector General. The Dodd-Frank Act ( P.L. 111-203 ) required an audit of the Fed's emergency activities during the financial crisis, released in July 2011, and an audit of Fed governance, released in October 2011. The effective result of the audit restrictions remaining in law is that GAO can audit the Fed's monetary policy decisions or operations, transactions with foreign central banks and governments, discount window operations, or policies related to bank reserves or securities credit for waste, fraud, and abuse, but cannot evaluate the economic merits of these actions.

The Fed's budget is not subject to congressional appropriations, limiting congressional oversight compared with appropriated agencies. Although Congress still sometimes attaches Fed "policy riders" to appropriations acts, in the absence of agency appropriations, Congress cannot prescribe the size or uses of the Fed's budget. The Fed is self-funded by fees and the income generated by securities it owns. Its income exceeds its expenses, and it remits most of its net income to the Treasury, where it is used to reduce the federal debt. The Fed uses a small portion of its net income to pay dividends to member banks and to add to its surplus when necessary.

For Fed disclosure, the Fed has publicly released extensive information on its operations, mostly on a voluntary basis. It is statutorily required to release an annual report and a weekly summary of its balance sheet. The expanded scope of the Fed's lending activities during the financial crisis eventually led it to release a monthly report that offered more detailed information. In December 2010, the Fed released individual lending records for emergency facilities, revealing borrowers' identities and loans' terms, as required by the Dodd-Frank Act. Going forward, individual records for discount window and open market operation transactions have been released with a two-year lag.

More recently, some Members of Congress have sought greater disclosure of information related to regulation (including international agreements), and salary and financial information about Fed officials and employees. In its rulemaking, the Fed follows the standard notice and public comment process and must consider the burdens and benefits for depository institutions, but is not required to conduct formal or quantitative cost-benefit analysis. The Fed has an ombudsman and an appeals process for its supervisory decisions, such as exam results. The Dodd-Frank Act created a vice chair for supervision who is required to testify before the committees of jurisdiction semiannually.

For more information, see CRS Report R42079, Federal Reserve: Oversight and Disclosure Issues , by [author name scrubbed].

Analysis

Although oversight and disclosure are often lumped together, they are separate issues and need not go together. Oversight relies on independent evaluation of the Fed; disclosure is an issue of what internal information the Fed releases to the public. Contrary to a common misperception, a GAO audit would not, under current law, release any confidential information identifying institutions that have borrowed from the Fed or the details of other transactions.

A potential consequence of greater oversight is that it could undermine the Fed's political independence. Most economists believe that the Fed's political independence leads to better policy outcomes and makes policy more effective by enhancing the Fed's credibility in the eyes of market participants. The Fed has opposed legislation removing remaining GAO audit restrictions on those grounds. Disclosure helps Congress and the public better understand the Fed's actions. Up to a point, this makes monetary and regulatory policies more effective, but too much disclosure could make both less effective because they rely on market-sensitive and confidential information. The challenge for Congress is to strike the right balance between a desire for the Fed to be responsive to Congress and for the Fed's decisions to be immune from political calculations and pressure.

A different standard of oversight and independence for monetary policy and the Fed's regulatory role might be conceptually desirable, but difficult to disentangle in reality. For example, if the Fed's regulatory budget were subject to congressional appropriations, Congress could potentially adjust that budget in response to disagreements about the Fed's monetary policy decisions.

Policy Proposals

GAO Audit. H.R. 10 would remove statutory restrictions on GAO audits of monetary policy and would require an annual audit that is not subject to current statutory provisions, such as confidentiality requirements. H.R. 24 would remove statutory restrictions on GAO audits of monetary policy and require a one-time GAO audit of the Fed that is not subject to statutory restrictions. Effectively, this would expand GAO's powers to allow it to evaluate the economic merits of the Fed's policy decisions.

Blackout Period. H.R. 10 , H.R. 4756 , and H.R. 6741 would mandate a media blackout period lasting from one week before to one day after an FOMC meeting, in which monetary policy decisions are made.

Testimony and Report to Congress on Monetary Policy . H.R. 10 would increase the frequency of the Fed's required monetary policy reports to Congress from semiannually to quarterly and would require the chair to testify on monetary policy before the committees of jurisdiction quarterly instead of semiannually.

Vice C hair of Supervision. The Dodd-Frank Act created the position of vice chair of supervision on the Board of Governors and required the vice chair to testify on Fed supervision semiannually. H.R. 10 would change the frequency of testimony to quarterly and require a written report on ongoing rulemaking to accompany that testimony. H.R. 10 , H.R. 4753 , and H.R. 6741 would also require the chair to testify in place of the vice chair if the latter position is vacant.

Release of FOMC Transcripts. H.R. 10 would require FOMC transcripts to be made publicly available. Currently, the Fed voluntarily releases the transcripts to the public with a five-year lag and FOMC meetings minutes with a six-week lag.

Appropriations. H.R. 10 , H.R. 4755 , and H.R. 6741 would subject the nonmonetary policy functions of the Fed's Board of Governors and 12 privately owned regional banks to the congressional appropriations process. It would require the Fed to assess fees to cover the costs of appropriations, which would become offsetting collections to these appropriations in the federal budget. Expenses are currently financed primarily out of income earned on the Fed's securities holdings. Because the Fed remits most of its net income to the Treasury, CBO estimated that the new fees would increase federal revenues. A similar provision was also included in the FY2018 Financial Services and General Government Appropriations Act ( H.R. 3280 ), as reported, and an omnibus appropriations act ( H.R. 3354 ), as passed by the House.

Disclosure of Supervisory Information. H.R. 10 would require the Fed to determine its stress test scenarios through the public rulemaking process and provide those scenarios to GAO and CBO's Panel of Economic Advisers. Currently, the scenarios are not disclosed to the banks or the public, but the stress test process was publicly described through the standard rulemaking process.

Cost-Benefit Analysis Requirements . H.R. 10 would subject all federal financial regulators, including the Fed, to quantitative cost-benefit analysis when issuing new rules and retrospectively five years after a final rule is issued.

Disclosure of International Negotiations. H.R. 10 would require the Fed (and other federal banking regulators) to notify the committees of jurisdiction and the public and solicit public comment at least 30 days before it enters into and at least 90 days before it completes international negotiations on financial standards.

Disclosure of Salaries and Financial Information . H.R. 10 , H.R. 4791 , and H.R. 6741 would require the public disclosure of salary and personal finances for all Fed governors, officers, and employees of the Federal Reserve Board of Governors with a salary above the equivalent of GS-15 on the government scale.

Rules-Based Monetary Policy (The Taylor Rule)

Background

Congress has granted the Fed broad discretion to conduct monetary policy as it sees fit as long as it strives to meet its statutory mandate. This discretion includes autonomy over what policy tools to use (e.g., whether policy should be carried out by targeting the federal funds rate) and what the stance of monetary policy should be (e.g., at what level should the federal funds rate target be set?).

Some Members of Congress, dissatisfied with the Fed's conduct of monetary policy, have looked for alternatives to the current regime. Some opponents of Fed discretion argue for a rules-based regime. One example of a monetary policy rule is the Taylor rule, which was developed by Economist John Taylor to describe and evaluate the Fed's interest rate decisions.

Normally, the Fed carries out monetary policy primarily by setting a target for the federal funds rate. The Taylor rule is a simple mathematical formula that, in the best-known version (described in the text box below), relates interest rate changes to changes in the inflation rate and the output gap. These two factors directly relate to the Fed's statutory mandate to achieve "maximum employment and stable prices."

Taylor rules are currently used in economic analysis to explain the Fed's past actions or to offer a baseline in an evaluation of what the Fed has done or should do in the future. A Taylor rule (although with different parameters from this example) has been demonstrated to track actual policy relatively well for the period lasting from after inflation declined in the 1980s to the beginning of the financial crisis in 2007. Thus, it can be used in an economic model (which offers a simplified version of the actual economy) to represent the Fed's decisions under normal economic conditions.

A limitation of the Taylor rule is that it was designed only to be used with the federal funds rate, which was the Fed's primary monetary policy instrument from roughly the early 1990s to late 2008. From December 2008 to October 2014, the Fed did not use the federal funds rate as its primary policy tool because the rate was at the "zero lower bound"—it was set near zero, and thus could not be lowered further. Instead, the Fed created new policy tools such as "quantitative easing" (QE) to stimulate the economy. The Taylor rule cannot make policy prescriptions at the zero lower bound—different combinations of deflation (falling prices) and output gaps would prescribe a negative federal funds rate under the Taylor rule, but that prescription would not be actionable because the federal funds rate is a market rate. The Taylor rule was devised at a time when interest rates had never fallen to the zero bound before, and it arguably seemed reasonable at the time to assume that the rule would not need to cover this contingency.

Analysis

Economists and policy analysts have debated whether basing monetary policy decisions on a Taylor rule would lead to better economic outcomes than the status quo. The Fed already uses the Taylor rule as a reference tool to help inform its policy decisions. Proponents would like the Taylor rule to have a more formal role in policymaking, either requiring policy to be set by a Taylor rule or requiring the Fed to explain its decisions relative to a Taylor rule following each FOMC meeting. (The Fed already presents a comparison of its current monetary policy to various Taylor rules in its semiannual Monetary Policy Report to Congress.) Under current law, if the Fed desired, it could arguably adopt these proposals voluntarily (e.g., the FOMC could agree to base their vote on a Taylor rule's prescription). Legislative changes would be needed to require the Fed to adopt these proposals, however.

The desirability of basing policy on a Taylor rule (whether it takes the form presented above or an alternative form) can be viewed through the prism of the economic debate about the superiority of rules versus discretion in policymaking. Economists who favor the use of rules argue that policy is more effective if it is predictable and transparent. They argue that unpredictable policy results in financial and economic instability. For example, there can be large movements in financial prices when the Fed makes a policy change that "surprises" financial markets. In addition, a formal role for a Taylor rule could potentially help Congress in its oversight capacity by providing a clear benchmark against which the Fed's decisions could be evaluated.

Economists favoring discretion argue that policymakers need flexibility to manage an inherently complex economy that is regularly hit by unexpected shocks. For example, rules might have hindered the Fed's ability to respond to the housing bubble and the financial crisis in the late 2000s. In principle, a Taylor rule need not be limited to inflation and the output gap, but making it more complex would reduce the perceived benefits of transparency and predictability. Likewise, periodically modifying the form that the Taylor rule takes in response to unforeseen events would reduce predictability and increase discretion. Further, how could a Taylor rule incorporate amorphous concerns about, say, financial stability or asset bubbles when there is no consensus on how to quantify them? A Taylor rule requires data points that are easy to measure and accurately embody a larger economic phenomenon of concern. Using forecasts would probably be preferable to using actual data in the Taylor rule because monetary policy affects the economy with lags, but would potentially reintroduce policy discretion (because the Fed would produce the forecast). Furthermore, if perceived policy errors were mainly caused by forecasting errors (e.g., the failure to identify the housing bubble), then using a Taylor rule based on forecasts would probably not have prevented them. Any of these issues could be addressed by modifying the Taylor rule, but this would arguably reduce the perceived benefits of a rules-based regime.

Other practical challenges with formalizing the use of the traditional Taylor rule in policymaking include (1) the requisite data are released with lags and later revised; (2) the neutral rate of interest and potential output growth cannot be directly observed and may vary over time, making them difficult to estimate accurately in real time; (3) a FFR based only on inflation and the output gap would make it more volatile; (4) public comprehension; and (5) how to address the zero bound issue.

Originally, rules were favored by economists who believed that Fed discretion was responsible for high inflation, but inflation has been low since the 1990s and below 2% by the Fed's preferred measure since 2013. Recently, Taylor rules have been used to support criticism that the Fed has engaged in too much stimulus. Policy rules in general do not inherently have a pro- or anti-stimulus bias, however, as their parameters can be adjusted to meet policymakers' goals. Policymakers who emphasize price stability could put a relatively high weight on the inflation parameter. Alternatively, policymakers who want the Fed to be responsive to (high or low) growth could put a relatively high weight on the output gap parameter. Because the form that a Taylor rule takes involves, in part, value judgments about the goals of monetary policy and the best way to achieve those goals, choosing its form involves political trade-offs and economic modeling.

As mentioned above, as long as the Fed prefers discretionary policy, it can only be forced to adopt rules-based policy through legislation. It would arguably be difficult, however, for Congress to determine what would be the best form of Taylor rule for the Fed to follow or when the Fed should be allowed to deviate from the rule's prescription. It needs the Fed's cooperation to devise and implement a rules-based policy, but the Fed has little incentive to "tie its own hands." If Congress wanted the Fed to adhere to both the spirit and letter of any law that reduced the Fed's discretion, it may need to find legal carrots or sticks to succeed. But exposing the Fed to negative consequences when it does not follow the monetary policy that Congress prefers would be antithetical to the Fed's independence from Congress. It would provide Congress a new avenue to potentially apply political pressure on the Fed's monetary policymaking, even if that is not the proponents' intent. Thus, the challenge for proponents of rules-based policy is how to ensure less discretion without compromising the Fed's independence.

Policy Proposals

H.R. 10 would require the Fed to formulate a mathematical rule (called the "Directive Policy Rule") that would instruct it how to set monetary policy (e.g., prescribe the current level of the federal funds rate) that would achieve its mandate of stable prices and maximum employment based on macroeconomic variables. The Fed would be required to publish a five-year projection of inflation under its rule. H.R. 10 would also require the Fed to calculate a traditional Taylor rule (called the "Reference Policy Rule" in the bill), as described in the text box, and compare it to the Directive Policy rule. Within 48 hours of a policy decision, the Fed would be required to submit the prescription of its rule to GAO and the committees of jurisdiction. GAO would report to Congress if the Fed was in compliance with the act's requirements, and if it was not, it would trigger a GAO audit that was not subject to the normal statutory restrictions (described " Oversight and Disclosure Proposals " section above) and the Fed chair's testimony before the committees of jurisdiction.

H.R. 4270 and H.R. 6741 would require the Fed to annually publish a monetary policy strategy laying out its expectations for monetary policy that year. It would require the Fed to adopt 1-3 mathematical policy rules intended to represent how monetary policy reacts to changes in the economy. The Fed would be required to issue a report to the committees of jurisdiction semiannually on how the Fed's strategy or monetary policy decisions differ from the policy rules.

Emergency Lending

Background

Under normal authority, the Fed faces statutory limitations on whom it may lend to, what it may accept as collateral, and for how long it may lend. If the Fed wishes to extend credit that does not meet these criteria, it can turn to emergency lending authority found in Section 13(3) of the Federal Reserve Act.

The worsening of the financial crisis in 2008 led the Fed to revive this obscure provision to extend credit to nonbank financial firms for the first time since the 1930s. Using this authority, the Fed created six broadly based facilities (of which, five were used) to provide liquidity to primary dealers (i.e., certain large investment firms) and to revive demand for commercial paper and asset-backed securities. More controversially, the Fed offered special, tailored assistance exclusively to four firms that the Fed considered "too big to fail"—Bear Stearns, AIG, Citigroup, and Bank of America.

Credit outstanding (in the form of cash or securities) authorized by Section 13(3) peaked at $710 billion in November 2008. At present, all credit extended under Section 13(3) has been repaid with interest and all Section 13(3) facilities have expired.

Contrary to popular belief, under Section 13(3), the Fed earned income of more than $30 billion and did not suffer any losses on those transactions. The transactions exposed the taxpayer to greater risks than traditional lending to banks through the discount window, however, because in some cases the terms of the programs had fewer safeguards.

The restrictions in Section 13(3) placed few limits on the Fed's actions in 2008. However, in 2010, the Dodd-Frank Act added more restrictions to Section 13(3), attempting to ban future assistance to failing firms while maintaining the Fed's ability to create broadly based facilities. It also attempted to limit taxpayers' risk, prevent the Fed from removing assets (as was done in assistance to Bear Stearns and AIG), and terminate assistance in a timely fashion. The Dodd-Frank Act also required records for actions taken under Section 13(3) to be publicly released with a lag and required GAO to audit those programs for operational integrity, accounting, financial reporting, internal controls, effectiveness of collateral policies, favoritism, and use of third-party contractors.

For more information, see CRS Report R44185, Federal Reserve: Emergency Lending , by [author name scrubbed].

Analysis

The Fed's use of Section 13(3) in the financial crisis raised fundamental policy issues:

Should the Fed be lender of last resort to banks only or to all parts of the financial system? Is this a more appropriate role for the Fed or Treasury? Should the Fed lend to firms that it does not supervise? How much discretion does the Fed need to be able respond to unpredictable financial crises? Do emergency lending benefits, such as quelling liquidity panics, outweigh the costs, including moral hazard? Should Fed emergency lending be approved by Congress? Would the need for congressional approval create market uncertainty that caused financial instability? Would Congress act fast enough to maintain financial stability? How can Congress ensure that taxpayers are not exposed to losses? How can Congress ensure that Section 13(3) is not used to "bail out" failing firms? Should the Fed tell Congress and the public to whom it has lent? Would that result in a stigmatizing effect that made firms in need of liquidity unwilling to borrow from the Fed?

Fed governor Jerome Powell has opposed further reducing the Fed's discretion under Section 13(3) on the grounds that the Fed needs "to be able to respond flexibly and nimbly" to future threats to financial stability. Although Section 13(3) must be used "for the purpose of providing liquidity to the financial system," some Members of Congress have expressed interest in—while others have expressed opposition to—the Fed using Section 13(3) to assist financially struggling entities, including states, municipalities, and territories of the United States.

Policy Proposals

Some Members of Congress believe that the Dodd-Frank Act did not sufficiently limit the Fed's discretion. H.R. 10 , H.R. 4302 , and H.R. 6741 would amend Section 13(3) to limit the Fed's discretion to make emergency loans. Changes can be divided into a few categories:

Preconditions for U se . H.R. 10 , H.R. 4302 , and H.R. 6741 would limit 13(3) to "unusual and exigent circumstances that pose a threat to the financial stability of the United States." H.R. 10 would require "the affirmative vote of not less than nine presidents of Federal reserve banks" in addition to the current requirement of the affirmative vote of five Fed governors, while H.R. 4302 would require "the affirmative vote of not less than two-thirds of the members of the FOMC."

Collateral. H.R. 10 , H.R. 4302 , and H.R. 6741 would forbid the Fed from accepting as collateral equity securities issued by a borrower. The bills would also require the Fed to issue a rule establishing how it would determine sufficiency of collateral, acceptable classes of collateral, any discount that would be applied to determine the sufficiency of collateral, and how it would obtain independent appraisals for valuing collateral.

Eligibility . H.R. 10 , H.R. 4302 , and H.R. 6741 would eliminate the current language permitting the Fed to establish a borrower's solvency based on the borrower's certification and would specify that before a borrower may be eligible for assistance, the Fed's board and any other federal banking regulator with jurisdiction over the borrower must certify that the borrower is not insolvent. The bills would limit assistance to institutions "predominantly engaged in financial activities" and preclude assistance to federal, state, and local government agencies and government-controlled or -sponsored entities.

Lending Rate. H.R. 10 , H.R. 4302 , and H.R. 6741 would require the Fed to issue a rule establishing a minimum interest rate on emergency loans based on the sum of the average secondary discount rate charged by the Federal Reserve banks over the most recent 90-day period and the average of the difference between a distressed corporate bond index (as defined by a Fed-issued rule) and the Treasury yield over the most recent 90-day period.

Congressional Approval. H.R. 4302 and H.R. 6741 would require a joint resolution to be enacted into law within 30 days of congressional notification or else a lending facility created under Section 13(3) would automatically terminate. The joint resolution would be considered under special expedited ("fast track") parliamentary procedures.

The Fed's Balance Sheet

Background

Before the financial crisis, the Fed balance sheet predominantly consisted of Treasury securities that it acquired through open market operations (financial transactions in secondary markets to implement monetary policy). In response to the financial crisis, the Fed acquired over $1 trillion of mortgage-backed securities (MBS) and other debt issued by the government-sponsored enterprises (GSEs). The Fed is now gradually reducing its holdings of MBS with the goal of eventually returning to a Treasury-only balance sheet. In the meantime, the Fed will continue to hold large amounts of MBS for the next several years under current plans.

In addition, the Fed acquired more exotic private securities through some of its 13(3) lending facilities during the financial crisis. These securities matured or were sold off relatively quickly after financial conditions stabilized, and only residual holdings have remained since 2012.

Analysis

The types of assets that the Fed can purchase through open market operations are relatively limited under current law. The types are limited to reduce the riskiness of the Fed's portfolio and to limit the Fed's influence on the allocation of credit—were the Fed to purchase securities issued by specific private firms, it could have an outsized effect on those firms' cost of credit relative to their competitors.

The Fed may purchase any type of security fully guaranteed by the federal government or a federal agency. As a practical matter the Fed has not held most agencies' securities because there are few federal agencies that issue publicly traded securities in large amounts or at all. For the purposes of this statutory provision, notable exceptions are the GSEs (Fannie Mae, Freddie Mac, and the Federal Home Loan Banks) and Ginnie Mae. Although this authority far predates the financial crisis, it enabled the Fed to accumulate over $1 trillion in MBS guaranteed by these entities in an attempt to help stabilize housing markets. Unlike 13(3) lending, there are no comparable statutory restrictions or requirements on its ability to acquire or hold MBS through open market operations.

Outside of open market operations, the Fed's authority is largely limited to lending. Borrowers from the Fed post collateral to back loans, and the Fed could wind up acquiring this collateral if the loans are not repaid, however. The Fed allows a broader range of collateral to be posted than the types of securities it may purchase through open market operations. Furthermore, the Fed acquired some private securities during the financial crisis under 13(3) by lending to limited liability corporations (LLCs) that it created and controlled so that those LLCs could purchase assets that the Fed was not permitted to purchase through open market operations. In a joint announcement in March 2009, the Treasury and Fed stated a desire to transfer some of these assets to the Treasury in the long run, but never followed up on this announcement.

Policy Proposals

H.R. 4278 and H.R. 6741 would limit the types of securities that the Fed may acquire through open market operations to gold, Treasury currency (e.g., coins), or the direct obligations of the federal government, foreign central banks (e.g., foreign currency), or the International Monetary Fund (e.g., special drawing rights). This would eliminate the Fed's authority to purchase short-term municipal tax anticipation notes, foreign government bonds, and securities guaranteed by federal agencies (e.g., agency MBS). The bills would require the Fed to swap any other assets (that it already holds or subsequently acquires) for federal debt of equal market value with the Department of the Treasury. Currently, that would require it to swap its large MBS holdings and residual 13(3) holdings. The Treasury would issue new debt to swap with the Fed. Presumably, the Department of the Treasury's ability to issue debt to swap with the Fed would be limited by the debt limit, which the bills would not raise. They would also remove current statutory restrictions on the Fed's ability to buy debt directly from Treasury; this restriction is intended to prevent the Fed from "printing money to fund the budget deficit."

The bills would also repeal the Fed's authority to make emergency loans to groups of banks, a power that has not been used because the Fed also has the authority to lend to individual banks. They would also limit the use of mortgages as collateral backing discount window loans.

Concluding Thoughts

The proposals in this report are wide ranging and diverse but are united by the goals of increasing the Fed's accountability to Congress and decreasing Fed discretion. Whereas some provisions make minor changes, taken together the proposals would arguably reduce the Fed's independence from Congress somewhat. There is a long-standing policy debate about how independent regulatory agencies should be from Congress and the President, with proponents for independence arguing that it will lead to more technocratic decisionmaking and opponents arguing it leads to opaque, undemocratic, and unresponsive decisionmaking. For decades, the Fed has enjoyed an unusual degree of independence from Congress and the President compared with other government agencies, which has typically been justified in terms of insulating its monetary policy decisions from political pressures. To some extent, a trade-off between independence and accountability is unavoidable. Besides the Taylor Rule, few of the provisions reviewed in this report directly relate to monetary policy, but may indirectly influence monetary policy through changes in how decisions are made, who makes decisions, and Congress's oversight of those decisions.