The House Financial Services Committee has approved, by a vote of 43-26, a controversial bill sponsored by Congressman Ron Paul.  Usually, I find Ron Paul somewhat comical, and I sometimes sympathize with his libertarian tendencies.  In this instance, however, I’m worried that Ron Paul’s antics are going to do serious damage.

The importance of central bank independence cannot be overstated.  Study after study has shown that a central bank’s ability to make interest rate decisions free from political pressure is one of the most important variables in long-term performance.  (Indeed, my economics thesis at Bates discussed that subject.)  Despite all that clear evidence, Ron Paul and friends want to subject the Fed’s interest rate decisions to Congressional scrutiny.

Look, I’m all for limited government, and I understand the Ron Paul disciples’ instinct to oppose an institution as seemingly powerful as the Federal Reserve.  Even so, we need an institution to direct monetary policy, whether we like it or not.  Do we really want Congress (current approval rating: 27%) to direct that policy?  Do we really want veterinarians calling the shots over trained professionals?  As Barry Ritholtz explained:

While I have been critical of the Federal Reserve (especially the Greenspan years), my beef with them has been their judgment and decision-making process. Congress, on the other hand, is a whole different matter. Its not their judgment, but rather, the fact they are owned not by the American people, but by lobbyists, and corporate interests. They have become structurally deformed.

How weird is it for me, who spent so many pages blaming the Fed for a lot of the recent crisis, to find myself in a position of defending them from outside political pressure? The choice we face is the recent Fed regime of secrecy, nonfeasance, irresponsibility, and easy money — versus something possibly likely to be a whole lot worse.

To be found in “contempt of Congress” would require an improvement in opinion of them.

If the Fed has been a major source of problems, Congress is much worse. They were the great enablers of the crisis, readily corruptible, bought and paid for by the banking industry. I find Congress to be the worse of two evils — lacking in objectivity, incapable of producing legitimate regulatory review.

If the Fed is Wall Street’s bitch, then Congress is the Street’s whore.

Some would argue [PDF] that an audit is not too much to ask.  To a certain extent, they’re right, and that’s why the Fed is currently subject to audit in most spheres.  But the mere perception of political influence in monetary policy, even if never exercised, is enough to distort the market and seriously @#%T^ up the money supply.  The market knows that politicians with an eye toward the short-term may be willing to use an audit (or the threat of an audit) as just another bargaining chip to gain political goodies.  (It is my understanding that audit threats are already a tool currently used to rein in other agencies.)  The market will, therefore, punish the dollar, regardless of whether or not Congress uses the audit as an in to further control.  Don’t believe me?  It’s already happening.

Paul has advanced his position by constructing an “us vs. the evil bankers” narrative that his followers have eaten up.  Frankly, I don’t understand the logic.  Because they hold debt, bankers don’t want to see an inflated currency — inflation makes the money they get back from borrowers worth a lot less than it was worth when lent.  So even if it were true that bankers “ran the Fed” (which is a dubious premise, to be sure), they would still produce beneficial monetary policy.   

Shame on you, Ron Paul, for not doing your economics homework.  Shame on you.

-Michael