It's all too obvious that financial reform is needed, but the details are in the hands of politicians with disparate agendas. Add to that lobbying of various interest groups and a soap opera on regulatory change ensues. The entity with the least political power, but the most economic influence is the Federal Reserve. So it's only natural that politicians are considering taking some of that power for themselves. (For background info, read our Federal Reserve Tutorial.)
Monetary Policy vs. Fiscal Policy
The Federal Reserve sets monetary policy for the United States. Monetary policy impacts the economy far more than fiscal policy which is controlled by Congress and the president. Monetary policy acts much faster, is more sweeping, and is larger in size than fiscal policy.

Also, monetary policy can be reversed fairly easily compared to fiscal policy. For example, once a spending bill has been signed, the money is spent. But the Fed can decrease the money supply as fast as it increases it. The fiscal policy that would slow the economy would likely be an increase in taxes. Not exactly a workable mechanism for politicians.

For evidence of the impact of monetary policy vs. fiscal policy just watch the financial markets when the Fed speaks vs. the Congress or the president. The markets parse every word of the Fed, looking for some change in policy or inclination there might be a future change. The president, Treasury secretary, and leaders in Congress can rail on about what they are going to do for the economy and the market barely pays attention. (For more, check out Formulating Monetary Policy.)

Recent Legislation
The Fed's dual mandate of high employment with stable prices would seem to be as bipartisan as anything ever could be. Who doesn't want high employment with stable prices? But because the Fed also is the lender of last resort, a role it played extensively in the recent crisis, the Fed is as independent as any government entity can be, and when economic conditions are less than perfect, this autonomy provides an opportunity for a power grab by the politicos.

This gives rise to the recent legislation that attempts to reduce the Fed's power and allow Congress to have more control. This is a catastrophic mistake.

The Fed's Important Independence
The importance of the independence of the Fed can't be overstated. Without it, we would never have become the country we are today. Why? Because politicians don't have the will to make the tough decisions in election years. And as every year seems to be an election year, they will put their own interest first and that means monetary policy will suffer.

For example, when inflation is rising, it's the Fed's job to reduce it. It does this by increasing interest rates and reducing money supply. This slows the economy. What politician running for election would ever be in favor of slowing the economy? When unemployment is still over 10%, it's likely the Fed will be raising interest rates to combat inflation. There will be cries from politicians that this isn't helping the job situation. They are right, but they are misguided. Inflation makes everyone poor, unemployment only impacts a small, but vocal, portion of the population. This leads to the old saying that it's the Fed's job to take away the punch bowl just as the party is getting started. Not exactly the way to get votes.

Other examples come from other countries where the separation of monetary policy and fiscal policy isn't as strong. Hyperinflation, a result of printing too much money to do things you can't afford, is strongly related to the lack of central bank independence. And even more regular rates of inflation are correlated as the less independence in the central bank, the higher the average inflation. Basically, politicians have difficulty with tough love, which is what stopping inflation is all about.

Bottom Line
While there are several proposals circulating on new financial regulations and there is plenty of time for cooler heads to prevail, it's unnerving to see leaders moving toward such obviously disastrous policy. In fact, what we should be doing is moving in the other direction. We should be limiting the politicians' role in the economy as they are the ones that allowed banks, investment firms and insurance companies to merge. They are the ones that regulated Fannie Mae and Freddie Mac. And, more importantly, they are the ones that are lobbied heavily by every special interest group and have to run for election using those groups' contributions.

Should the Fed's power be reduced? No, just the opposite.

For further reading, check out The Treasury And The Federal Reserve.

Related Articles
  1. Fundamental Analysis

    5 Basic Financial Ratios And What They Reveal

    Understanding financial ratios can help investors pick strong stocks and build wealth. Here are five to know.
  2. Options & Futures

    4 Equity Derivatives And How They Work

    Equity derivatives offer retail investors opportunities to benefit from an underlying security without owning the security itself.
  3. Investing News

    What's the Fed Going to do in 2016?

    Learn about the factors that contribute to increases in the federal funds rate by the Federal Reserve and key economic indicators for 2016.
  4. Investing

    What Investors Need to Know About Returns in 2016

    Last year wasn’t a great one for investors seeking solid returns, so here are three things we believe all investors need to know about returns in 2016.
  5. Options & Futures

    Five Advantages of Futures Over Options

    Futures have a number of advantages over options such as fixed upfront trading costs, lack of time decay and liquidity.
  6. Forex

    The Consumer Price Index

    Find out how this economic measure can help you make key financial decisions.
  7. Economics

    Understanding the History of Money

    Money has been a part of human history for at least 3,000 years, evolving from bartering to banknotes.
  8. Term

    What is Pegging?

    Pegging refers to the practice of fixing one country's currency to that of another country. It also describes a practice in which investors avoid purchasing security shares underlying a put option.
  9. Home & Auto

    Understanding Pre-Qualification Vs. Pre-Approval

    Contrary to popular belief, being pre-qualified for a mortgage doesn’t mean you’re pre-approved for a home loan.
  10. Economics

    The Basics Of Business Forecasting

    Whether business forecasts pertain to finances, growth, or raw materials, it’s important to remember that a forecast is little more than an informed guess.
RELATED FAQS
  1. What is a derivative?

    A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, ... Read Full Answer >>
  2. What is finance?

    "Finance" is a broad term that describes two related activities: the study of how money is managed and the actual process ... Read Full Answer >>
  3. What is comparative advantage?

    Comparative advantage is an economic law that demonstrates the ways in which protectionism (mercantilism, at the time it ... Read Full Answer >>
  4. What is after-hours trading? Am I able to trade at this time?

    After-hours trading (AHT) refers to the buying and selling of securities on major exchanges outside of specified regular ... Read Full Answer >>
  5. How does the Wall Street Journal prime rate forecast work?

    The prime rate forecast is also known as the consensus prime rate, or the average prime rate defined by the Wall Street Journal ... Read Full Answer >>
  6. What is the difference between positive and normative economics?

    Positive economics is objective and fact based, while normative economics is subjective and value based. Positive economic ... Read Full Answer >>
Hot Definitions
  1. Discouraged Worker

    A person who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment ...
  2. Ponzimonium

    After Bernard Madoff's $65 billion Ponzi scheme was revealed, many new (smaller-scale) Ponzi schemers became exposed. Ponzimonium ...
  3. Quarterly Earnings Report

    A quarterly filing made by public companies to report their performance. Included in earnings reports are items such as net ...
  4. Dark Pool Liquidity

    The trading volume created by institutional orders that are unavailable to the public. The bulk of dark pool liquidity is ...
  5. Godfather Offer

    An irrefutable takeover offer made to a target company by an acquiring company. Typically, the acquisition price's premium ...
Trading Center