We need a new regulatory structure that provides for comprehensive and consistent oversight of all elements of the financial system. This includes effective consolidated oversight of all our largest and interconnected financial institutions and oversight of payment and settlement systems. We must make sure that the people doing the regulation have the power and expertise to ferret out and bring to heel regulatory evasion as it occurs to prevent abuse and excess from building up in the financial system. In the end, the gaps, not the overlaps, have been the main shortcoming of our existing regulatory framework. A second fundamental point is that regulatory reform has to ensure that the financial system will be robust and resilient even when it comes under stress so that it will not fail in its critical role in supporting economic activity. No economy can prosper without a well-functioning financial system – one that efficiently channels savings to the businesses that can make the most productive use of those savings, and to consumers that need credit to buy a home and support a family. The fact that our financial system isn’t functioning well right now is part and parcel of our current economic difficulties. This critical link between the “real” and the “financial” is why we care so much about the systemic risks inherent in banking and finance. One critical element of systemic risk is what is known as the “too big to fail” problem.
This gives the Fed more latitude not to tighten when inflation rises for transient reasons – say, due to a short-lived spike in oil prices – and more scope to ease credit to support the economy during economic downturns. Recognizing these benefits, Congress wisely acted many years ago to exempt monetary policy decisions from the GAO’s wide powers to review Federal Reserve activities. Congress’ decision to bolster the Fed’s monetary policy independence has been followed by similar actions around the world – substantial independence for the central bank in the conduct of monetary policy is now widely regarded as international best practice. Policy independence does not absolve the Federal Reserve from accountability for its monetary policy decisions and the need to clearly explain why they were taken. But it avoids the politicization of monetary policy decision-making. And this is good because politicized central banks generally do not have enviable records with regard to inflation, economic growth or currency stability. Risk premia on financial assets are typically much higher in countries with politicized central banks. Of course, a reversal of Congress’s earlier decision would not amount to legislative control over monetary policy decisions. That’s not the issue. The issue is that a reversal of Congress’ earlier decision could create the appearance that the legislature seeks to influence monetary policy decisions by establishing a mechanism to publicly second guess those decisions. Such a move would blur what has been a careful separation of monetary policy from politics.