Yellen warns proposed law on Fed would damage US economy

Janet Yellen warned Tuesday that a proposed law in Congress to more closely oversee the Federal Reserve would politicize monetary policy and do deep harm to the US economy.

The "Fed Oversight Reform and Modernization Act" would tie the hands of Fed policy-makers to a formulaic rule that, if in place during the last six years, would have greatly worsened the impact of the economic crisis, Yellen said in a letter to House Speaker Paul Ryan and House Democratic leader Nancy Pelosi.

"This legislation would severely damage the US economy were it to become law," she wrote.

It would also "likely lead to... a diminished status of the dollar in global financial markets, and reduced economic and financial stability."

Setting up an economic rule to guide Fed monetary policy, as the FORM Act proposed, "would essentially repeal the Federal Reserve's remaining ability to act in a crisis."

The act, which passed through the House Financial Services Committee on July 29, was to come up for a formal vote in the full House of Representatives this week. It aims to make Fed policy-making "more predictable" and "more transparent," according to the committee.

Committee leaders say the Fed is too opaque and needs to regularly demonstrate "how its policy choices compare to a benchmark rule."

"The Fed favors a more unpredictable 'forward guidance' approach to monetary policy, which we've seen lacks clarity and creates economic uncertainty," said committee chairman Jeb Hensarling in a statement last week.

"The FORM Act corrects these problems through increased transparency and accountability instead of policy mandates, which would subject the Fed to further political pressures."

But Yellen countered, arguing the Fed is transparent and that the new bill "would politicize monetary policy" and "bring short-term political pressures" into monetary policy decision making.

The act would effectively put Congress "squarely in the role of reviewing short-run monetary policy decisions" by constantly assessing policy outcomes against the fixed rule.

If the Fed had been forced to abide by the proposed mathematical rule during the crisis years, she said, "the unemployment experience of that period would have been substantially more painful than it already was."