MCKEE: Very quickly, let me ask you, last question, Donald Trump says he would get rid of Janet Yellen and appoint someone who shares his views on interest rates and policy. What would that mean for Fed credibility?

LACKER: I think it would be problematic for a presidential candidate to dismiss a Fed chair on the basis solely of the perceived party affiliation.

The Federal Reserve's accountability structure has been largely stable since the 1970s reforms. At the same time, the Federal Reserve has greatly augmented its public communications about its economic outlook and its policy strategy.
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This increased transparency has been a key complement to the Fed's independence and accountability by regularly demonstrating that the Fed has been appropriately pursuing its mandated goals. Transparency can also make monetary policy more effective by helping to guide the public's expectations and clarify the Committee's policy intentions.

If effective monetary policy means taking away the punch bowl just as the party gets going, then effective financial stability policy might mean taking away the punch bowl before the guests have even arrived because the risks to financial stability build up over time and action likely needs to be taken earlier in order to be effective. Contributing to the need for early action is the challenge of having to coordinate policy action across multiple regulatory bodies. If the need for monetary policy to be forward looking is a difficult concept for the public to grasp, the need for financial stability policy to act well before there are clear signs of instability may be even more difficult to explain. In thinking about the design of the financial stability regime, it might behoove policymakers to consider whether it would be better for central banks to keep their monetary policy and financial stability policy discussions separate so as to avoid jeopardizing the independence of monetary policy.

Whereas the Fed used to be able in unusual circumstances to lend to non-banks in a crisis, it cannot now extend help to individual firms under revised laws. It must provide loans to a broader class of institutions with the Treasury secretary’s permission, and with notification being made to Congress. Mr Fischer said this restriction “has gone about as far as it should”.

“If we ever did find ourselves not able to use powers, which are inherent in the institution of a central bank, because someone decided we should manage without that because it creates moral hazard, for example, I think we pay a very high price. I don’t want to throw away things that could be useful because I am worried about this, that or the other,” he said.

BARTIROMO: Let me turn your attention to the Federal Reserve firing back at people like Rand Paul. Senator Paul wants this legislation out there, audit the Fed legislation, and he would like Congress to have more oversight over the central bank, which a lot of people feel is going to get more traction with a GOP-led Congress. What do you think?

PLOSSER: Well, I think this is a risky strategy for monetary policy. The Fed is already audited; we publish our balance sheet every week. This is not about financial auditing; this is about policy audits, if you will. And I think it would be very dangerous for the Fed to become ever more politicized by Congress and the government second-guessing policies that they there made.

The Congress has wisely given the Fed the tools it needs to implement monetary policy and respond to future crises as well as crucial independence to do its work free from short-term political influence. I would urge caution regarding current proposals that threaten just such political influence and place restrictions on the very tools that so recently proved essential in preventing a new depression. Congressional oversight of the Federal Reserve, including its conduct of monetary policy, is extensive, but no doubt could be improved in ways that do not threaten the Fed's effectiveness.

"I'll be blunt: we are audited out the wazoo," Dallas Fed President Richard Fisher said on Fox Business Network. "This (bill) is about interfering with the making of monetary policy. I respect the gentleman from Kentucky but he is wrong," Fisher said of Senator Rand Paul, who backs the bill.

Think about this: Heres a Congress that cant even get its own budget together. Do you want them running the central bank?

Take it to the extreme: We would end up playing to the cameras, which is what Congress does, and it would be a disaster, if Congress decided to audit Fed decisions, said Fisher, a former Democratic candidate for the Senate.

Those of us who are the current trustees of the Fed's reputation- the FOMC- must be especially careful that nothing we do appears to be politically motivated. In nourishing the growth of the economy and employment, we must avoid erring on the side of coddling inflation to compensate for the inability of fiscal and regulatory policy makers in the legislative and executive branches to do their job. We must continue to protect the independence of the Fed.

I was uncomfortable with QE3, the program whereby we committed to a sustained purchase of $85 billion per month of longer-term U.S. Treasury bonds and mortgage-backed securities (MBS). I considered QE3 to be overkill at the time, as our balance sheet had already expanded from $900 billion to $2 trillion by the time we launched it, and financial markets had begun to lift off their bottom. I said so publicly and I argued accordingly in the inner temple of the Fed, the Federal Open Market Committee (FOMC), where we determine monetary policy for the nation. I lost that argument. My learned colleagues felt the need to buy protection from what they feared was a risk of deflation and a further downturn in the economy. I accepted as a consolation prize the agreement, finally reached last December, to taper in graduated steps our large-scale asset purchases of Treasuries and MBS from $85 billion a month to zero this coming October. I said so publicly at the very beginning of this year in my capacity as a voting member of the FOMC. As we have been proceeding along these lines, I have not felt the compulsion to say much, or cast a dissenting vote.

However, given the rapidly improving employment picture, developments on the inflationary front, and my own background as a banker and investment and hedge fund manager, I am finding myself increasingly at odds with some of my respected colleagues at the policy table of the Federal Reserve as well as with the thinking of many notable economists.

[W]ith low interest rates and abundant availability of credit in the nondepository market, the bond markets and other trading markets have spawned an abundance of speculative activity. There is no greater gift to a financial market operatoror anyone, for that matterthan free and abundant money. It reduces the cost of taking risk. But it also burns a hole in the proverbial pocket. It enhances the appeal of things that might not otherwise look so comely. I have likened the effect to that of strapping on what students here at USC and campuses elsewhere call beer goggles. This phenomenon occurs when alcohol renders alluring what might otherwise appear less clever or attractive. And this is, indeed, what has happened to stocks and bonds and other financial investments as a result of the free-flowing liquidity we at the Fed have poured down the throat of the economy.

I feel, Congressman, that it would be a grave mistake for the Fed to commit to conduct monetary policy according to a mathematical rule. No central bank does that.

And I believe that although under the legislation we could depart from that rule, the level of short-term scrutiny that would be brought on the Fed in real-time reviews of our policy decisions would -- would essentially undermine central bank independence in the conduct of monetary policy.

And I believe that global experience has shown that we have better macro-economic performance when central banks are removed from short-term political pressures and given the independence to, within a framework in which their goals are clear, and in our case those are specified by Congress, given operational independence, decide how to conduct monetary policy.

The Federal Reserve is the most transparent central bank, to my knowledge, in the world. We have made clear how we interpret our mandate and our objectives, and provide extensive commentary and guidance on how we go about making monetary policy decisions.

Senator, I would welcome the appointment of a community banker to our board That said, I don't support requiring it via legislation. There are seven governorships. The board has many different needs. I think if we were to sit down and make a list of all of the kinds of expertise that are needed and are useful, there would be more than seven items on that list. And I would, you know, prefer to see appointments made in light of the priorities, including for a community banker, rather than for the indefinite future locking in and earmarking particular seats for particular purposes.

I feel that's a road that could go further in a direction that would worry me. If we're earmarking we could end up earmarking each seat for a particular kind of expertise. And I think greater flexibility needs due change over time. But that's not in any way to diminish my support for seeing a community banker appointed to the board.

MULVANEY: Chair Yellen, it appears that the FOMC has had at least two special hearings over the course of the last several years regarding the debt ceiling...
So, in light of the fact there've been at least two hearings where the technical aspects or the plans regarding the processing of federal payments have been raised, and the conclusions of both of those that it would not materially impact the conduct or procedures of the Fed, I'll ask you a simple question: Is there a contingency plan in place regarding federal payments -- the making of federal payments in the event the debt ceiling is not raised?
YELLEN: Not to the best of my knowledge.
MULVANEY: Then I'll ask you, Ms. Yellen -- thank you for that -- in the 2011 minutes, which read, "The staff provided an update on the debt limit status, conditions in the financial markets and, most importantly, plans that the Federal Reserve and the Treasury had developed regarding a process of federal payments," what were those plans that had already been developed as of at least August 2011?
YELLEN: Well I mean, we're discussing very technical issues connected with the payment system, for example, would the Treasury put through in the morning ACH payments that they might not have sufficient balances in their account to pay.
MULVANEY: And what would happen in such a circumstance?
YELLEN: Well, in such a circumstance , if they did that, banks would receive instructions in the morning to pay customers amounts that the Treasury wouldn't have in their checking account to make good on. And so their checks would bounce leaving those institutions in a very difficult situation...
MULVANEY: Are the plans that are referenced in the 2011 hearing in writing?
YELLEN: There are -- there are briefings that staff made to the Federal Open Market Committee when we met, when we met about what our plans would be in terms of the responsibilities...
MULVANEY: I understand that, but are the briefings based upon a written document? Are they based on some verbal history at the Fed or the Treasury? Is there a written down plan on these payments?
YELLEN: To the best of my knowledge, there is no written down...
MULVANEY: Given the fact that coming up with a contingency plan would have a great deal of impact on calming the markets in the face of a debt ceiling difficulty, do you think it's a good idea to develop a contingency plan for prioritization of payments in the event the debt ceiling is not raised?
YELLEN: That's a matter that is entirely up to the Treasury. That is not the domain of the Federal Reserve.
MULVANEY: But you have -- you perform the functions for the Treasury through the New York Fed, don't you?
YELLEN: With the Fed's -- with the Treasury's fiscal agent.
MULVANEY: If they asked you to do it, could you?
YELLEN: It is not up to us to develop a plan concerning what bills would be paid.
MULVANEY: If the Treasury asked you to create a program to put into place through the New York Fed could you do it?
YELLEN: I don't know that we could do that.
MULVANEY: Do you think it would be a good idea to do that?
YELLEN: Treasury submits to us every day a set of payments to make.
MULVANEY: I understand.
Let me finish with this, Ms. Yellen.
I appreciate that.
We have asked for the records from the Fed, specifics related -- identified in the meeting from the New York Fed. The New York Fed has told us we cannot have have them until they get permission to give them to us from the Treasury.
In light of your earlier comments to Ms. Bachmann and Ms. Posey regarding Fed independence, are you concerned about having to ask the Treasury for permission to give information to Congress?
YELLEN: Well, the Federal Reserve acts as the Treasury's fiscal agent, and in that case we take instructions from the Treasury and are merely acting as their agent. That's one of our roles to serve as the fiscal agent of the Treasury. It is not a monetary policy role.

These lending operations changed the composition of the Fed's asset portfolio without changing the Fed's monetary liabilities, and thus constituted "credit policy," not monetary policy.4 Such lending raises important issues related to the independence of central banks and their role in the financial system.5 I have spoken at length about these issues on other occasions, but they are not my focus today.6

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When a central bank uses its independent balance sheet to choose among private sector assets, it invites special pleading from interest groups and risks entanglement in distributional politics. Similar political risks face a central bank, such as the European Central Bank, allocating investments across multiple sovereign debt issuers.

Political pressure to channel credit to favored sectors is not without precedent in the United States. Congress gave the Fed authority to buy the debt of U.S. agencies such as the housing government-sponsored enterprises in 1966 in response to the "credit crunch" that year that reduced flows to housing finance… In 1971, the FOMC relented and began outright purchases of the debt of the housing government-sponsored enterprises.12 (By 1981, purchases had stopped, and the Fed's holdings ran off gradually over the 1980s and 1990s. Outright purchases of agency securities were not conducted again until early 2009.)

How central banks manage the political risks associated with forays into credit policy may prove pivotal for the evolution of central banking in advanced economies. A central bank's core responsibility revolves around its liabilities — that is, the monetary assets it uniquely supplies. Being organized as distinct, off-budget intermediaries, however, requires them to hold assets, and just what assets the central bank should hold has been something of a conundrum…

Of the risks associated with unconventional monetary policies, those associated with central bank holdings of unconventional asset classes may be the most consequential. Violating the implied truce under which central banks avoid credit policy has the capacity to perturb the delicate governance equilibrium supporting the independent conduct of monetary policy. History provides numerous examples of compromised central bank independence leading to calamitous monetary policy.

Let me just say a preliminary thing, which is I don’t think that the central bank should be equally independent in all of its functions. There are good reasons to have independence in monetary policymaking subject to a mandate or subject to objectives set by the democratic parliament or legislature. And we understand those reasons having to do with avoiding short-run political intervention in monetary policy and the like, but in many of its other activities — you know, for example, as a bank regulator, while we believe that bank regulators should be independent to make their own judgments about the quality of banks, I don’t think the Fed can presume to be any more or less independent in that function than is the OCC or some other bank regulator.

It’s just another aspect of our activities.

In our provision of payment services, there probably is no real case for independence, and it’s entirely appropriate for the Congress to ask questions about, you know, what we’re charging for those services and how we’re providing them and so on.

So I think it depends very much on the — on the aspect of the particular activity that the central bank is involved in.

So independence is a subtle concept. I think the — what it means varies according to the particular activity or particular function.