Audit the Fed? That's a terrible idea

In a week when Federal Reserve Chair Janet Yellen got grilled pretty hard on Capitol Hill, and Fed Vice Chair Stanley Fischer, said the central bank was likely to start raising interest rates this year, there were a couple items that stood out as important with respect to future policy decisions.

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Janet Yellen
Kevin Lamarque | Reuters
Janet Yellen

One is the movement to audit the Fed's interest-rate policy deliberations. Bad idea. Period. Letting Congress pressure the Fed on monetary policy is almost as dangerous as letting Congress decide on interest-rate policy itself. This is a group that can't decide to fully fund Homeland Security without falling on its sword. Best to leave interest-rate policy in the hands of the central bank, and fiscal policy, well, in the hands of some government body that can actually make a decision. (We can discuss Washington's shortcomings on that front another time!)

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There was also a steady drumbeat, among some congressmen and senators, to push the Fed into adopting a "black box" policy-making mechanism that would limit the Fed's discretion in setting policy, pretty much, at all times.

Chair Yellen was asked if she would be amenable to adopting the "Taylor Rule," to set the future course of interest rates.

She said no.

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Named for Stanford professor, John Taylor, the Taylor Rule" suggests that, when inflation is above a targeted rate (in this case, 2 percent), and when the economy is growing above its long-run potential, (say 4 percent), interest rates should be raised.

John Taylor, professor of economics at Stanford University
Tom Williams | CQ Roll Call | Getty Images
John Taylor, professor of economics at Stanford University

Conversely, when inflation and growth are below target, interest rates should be lowered.

This may surprise some conservative economists, and members of Congress, but the Fed has been following a modified "Taylor Rule," for over two decades.

Taylor first expanded on the work of others, arguing for a rules-based monetary policy, back in 1993.

Since then, the Fed has largely adhered to this policy prescription, and under most circumstances, has remained faithful to some form of the the Taylor Rule since it was first articulated.

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It appears not everyone on the Hill is aware of that, and not everyone has approved of Fed policy in recent years, despite the broad use of the rule, consistently, for quite some time. What might shock a few folks in Washington is that a strict interpretation, or implementation, of the rule might just demand an even easier policy from the Fed than we have today.

One could argue, and some have, that even with interest rates at zero, the Fed's policy is still too tight when compared to growth and inflation targets, although, unemployment, by its most narrow measure, is quite a bit closer to its maximum sustainable rate than at any time since before the Great Recession.

Still, inflation is well below both the Fed, and Taylor's target. Economic growth continues to underperform its long-run potential, despite the progress made in the last few years.

I am surprised that Chair Yellen didn't say that if she, and the Fed, were operating under strict Taylor Rule guidelines, the Fed would be doing even more to stimulate the economy than it is right now, and would continue to do so as long as inflation, and growth, remain below their long-run potential.

One Wall Street interest-rate trader said he likes the Bernanke interpretation of the Taylor Rule — not based on where we have been, but on where we are likely headed.

"This is what makes the rules approach impossible," the trader said. "If we don't trust the Central Bank to do the right thing, whatever it is ... Why have them?"

It would have been nice to see a few representatives flip through their Taylor Rule handbooks and realize that what they are asking for might actually deliver a policy with which they totally disagree.

Not only would their looks of surprise be delightful, but it might also send a few question-writing staffers back to academia to understand what it is they are actually proposing.

Commentary by Ron Insana, a CNBC and MSNBC contributor and the author of four books on Wall Street. He also editor of "Insana's Market Intellgence," available at Follow him on Twitter @rinsana.