By Kimberlee Kruesi

WASHINGTON (MNI) - Critics of Federal Reserve policy were given a forum at the libertarian Cato Institution Thursday, saying the central bank must be restrained from using so much discretion in intruding into banking and finance and should return to fundamentals.

Over the past two years the Fed has fallen away from the principle "rule of law," said Lawrence White, an economics professor at George Mason University and visiting scholar for the Federal Reserve Bank Of Atlanta, in a discussion sponsored by the Institute.

Under the "rule of law", the law is the highest authority where no one is exempt; governing bodies make sure to implement this principle, White said. The opposite is the "rule of authorities," where individuals in executive positions use discretion to make new laws to fit whatever the situation, he said, putting the Fed in that camp.

Throughout the height of the financial crisis and the current recovery, White and other panel members agreed the Fed is becoming increasingly more and more a "rule of authority" as it relies on its own discretion in monetary policy and financial reform.

"Discretion in monetary policy and financial regulatory policy does not give us better results," White said. "It is today widely recognized that inflation is inadvertently fostered by the discretionary policies of central banks where 'discretion' means the absence of precommitment to any fixed policy rule."

For example, the Fed departed from traditional bankruptcy laws in the case of the acquisition of Bear Stearns but did not follow the same precedent with Lehman Brothers, he said.

"They [the Fed] have been unorthodox and undeniably arbitrary, bestowing favors on some firms and burdens on others" White argued.

Recent Fed actions like bailing out certain institutions and not others are examples of the expanding Fed use of discretionary authority, agreed Thomas Humphrey, panelist member and a economist for the Federal Reserve Bank of Richmond for 35 years before retiring. He called the Fed "disappointing and appalling".

Yet the panel did not agree on what steps the Fed should take to correct its actions.

On one hand, Humphrey argued that "the Fed should abandon its expanded role and scale back its operations by lending to sound borrowers on good security and by providing emergency liquidity via open market operations to the market in general."

However, White called for a return to the gold standard which would set a strict limit on volume and credit created; a truly effective gold standard would eliminate the need for the Fed, he argued.

"A gold or silver standard, without a government central bank to loosen its constraints, will stop the banking system from following a path that inflates a bubble in asset prices," he argued.

Overall, the panel agreed that the Fed has expanded outside it's original intent and must be restrained as soon as possible.

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