Is the Fed Overfed?

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Dean Baker
San Francisco Chronicle, October 28, 2005

Baltimore Sun, October 28, 2005
St. Louis Post-Dispatch
, November 14, 2005
Washington Times
, November 22, 2005

Ben Bernanke, President Bush's choice to be the new chairman of the Federal Reserve Board, is a highly respected economist well-qualified to hold the position. However, the change of leadership, after Alan Greenspan's long tenure, provides a good opportunity to re-examine how the Fed works. Specifically, Congress should use this changing of the guard to modernize the way the Fed is financed.

The Fed's finances are an obscure mystery known only to a tiny group of policy wonks. Unlike most government agencies, Congress does not authorize funding for the Federal Reserve Board. The Fed was set up as a public/private entity by the Federal Reserve Act of 1913, and it survives off the money earned on the government bonds it holds. Each year, it pays out a portion of these earnings to its member banks across the country, as a return on the money they are required to invest in the Fed. It also uses some of its earnings to pay for the agency's operations. The rest of the money the Fed earns is returned to the Treasury, where it came from originally, as interest on government bonds. In effect, the Fed is allowed to spend as much as it wants for its operations -- at the expense of American taxpayers -- because higher expenses mean that less money is returned to the Treasury.

As may be expected, the cost of the Fed has been rising. The agency projects that it will spend $288 million in 2006. This compares with a budget of $156 million in 1994. Adjusting for inflation, this is still an increase of more than 45 percent. While the Fed's budget is not a big item in the context of the whole federal budget, Congress has had major battles over smaller sums.

One of the biggest items in the Fed's budget is monetary and economic policy, a category that will cost $112 million in 2006. Much of this money goes to fund economic research. While the Fed needs some research to do its job, much of this research has no obvious relationship to monetary policy. For example, the Dallas Federal Reserve Bank recently published articles on trade and climate change, Social Security reform and the economics of biotechnology. While these studies may have been quite useful, there is no reason that they should be paid for by taxpayers through the Fed. Congress should be able to determine the amount of economic research that it wishes to fund and then explicitly appropriate the money. The Fed should not be taking taxpayer money to finance this research through the back door.

To correct this problem, the Federal Reserve Board's budget should be subject to congressional approval, just as other federal agencies are. Will this jeopardize its independence? Unlikely. The U.S. Supreme Court has been relying on congressional appropriations for more than 200 years, and no one from either party has claimed that this funding restricts the court's independence from Congress.

In short, there really is no basis for allowing the Fed to have a blank check when it comes to funding its own operations. The situation is a historical relic of the legislation that created the Fed in 1913. With Congress set to debate Bernanke's appointment, it has a great opportunity to consider restructuring the nation's central bank. At a time when Congress is looking to trim money for children's health care, education and other important programs, there's no reason that taxpayers' dollars should be funneled to the Fed without any oversight. If the new Federal Reserve Board chairman can't sell his budget to Congress, then he's probably asking for too much money.


Dean Baker is Co-Director of the Center for Economic and Policy Research, in Washington, DC.