ANALYSIS-Fed's QE2 timing opens floodgate to critics

By Mark Felsenthal

WASHINGTON, Nov 15 (Reuters) - Criticism of the Federal Reserve's $600 billion bond buying program has moved from the right-wing Tea Party to the Republican mainstream but is unlikely to spark a legislative threat to Fed independence.

The success of activist GOP candidates in the mid-term elections that gave Republicans control of the House of Representatives in an anti-government backlash looks certain to lead to fresh scrutiny of the Fed's policy decisions.

In fact, prominent Republicans have already unleashed a torrent of criticism of the U.S. central bank's new bond buying plan, warning it is undermining the dollar, could lead to rampant inflation and treads on the fiscal policy domain that is the province of Congress.

But with Republicans set to control only one chamber of the legislature and a Democrat in the White House, these strident attacks -- which have led President Barack Obama to leap to the Fed's defense -- are unlikely to translate into new constraints on monetary policymaking.

"I don't think this translates into meaningful action ... that changes the authority of the Fed," said Douglas Holtz-Eakin, a former adviser to 2008 GOP presidential candidate John McCain.

Holtz-Eakin, now with the conservative think tank American Action Forum, is among a number of well-known Republican economists who have signed a letter to Fed Chairman Ben Bernanke urging him to drop the unorthodox effort to spur a stronger U.S. economic recovery.

"The planned asset purchases risk currency debasement and inflation, and we do not think they will achieve the Fed's objective of promoting employment," the group of 23 economists and business executives say in the letter, which will be published as a full-page newspaper advertisement this week.

An early taste of Republican discomfort with the Fed could come on Tuesday, when the Senate Banking Committee is scheduled to hold a second vote on the nomination of Nobel prize winning economist Peter Diamond to the central bank's board.

The top Republican on the panel, Richard Shelby of Alabama, has stated repeatedly that he thinks Diamond lacks the proper expertise for monetary policymaking.

WALKED INTO IT

The Fed cut rates to near zero in December 2008 to pull the economy out of a deep recession. In the following months it bought $1.7 trillion of mortgage-related debt and longer-term Treasuries to provide further stimulus, a policy known as quantitative easing.

The recovery, however, has proven disappointingly slow and unemployment stubbornly high. Fed officials launched a further round of asset purchases earlier this month.

The second guessing was fast and furious, not only from critics in the political sphere, but from nations worried about a weak dollar and from some officials inside the Fed as well.

From a political perspective, the timing of the Fed's announcement couldn't have been worse: it came the day after an election that was a smash success for candidates championing more limited government.

"The average populist doesn't distinguish between the Fed and other branches of government, and it's 'yet again, here they go,'" said Holtz-Eakin. "They walked right into it."

The No. 3 Republican in the House called it an effort to dilute the dollar and create inflation that would be "an incalculable risk". The top House Republican on the Joint Economic Committee said the inflation risks far outweighed any boost to economic growth the program might provide.

Former Republican vice presidential candidate and Tea Party favorite Sarah Palin also attacked it, calling on Bernanke to "cease and desist."

"We don't want temporary, artificial economic growth bought at the expense of permanently higher inflation," she said.

WALKING THE LINE

Republicans are concerned, in part, that the program goes over the heads of fiscal policymakers by providing a prop that lowers the government's borrowing costs.

"When the Fed buys Treasury bonds and seeks intentionally to drive down their price through increased inflation, that is fiscal policy," said Phillip Swagel, a Treasury Department official under former President George W. Bush.

The central bank has already weathered a firestorm of criticism that sprung up from its aggressive efforts to beat back the financial crisis and prop up financial institutions.

Officials had worried Congress might put in place a plan to audit the central bank's monetary policy decisions. They warned the proposal would tread on their political independence and they successfully fought it off.

The sponsor of that measure, Republican Representative Ron Paul, has vowed to try to resurrect the plan.

But even critics caution against moves that would undermine the central bank's ability to conduct policy free from political interference.

Swagel, like Holtz-Eakin, thinks that while more scrutiny is likely, legislation isn't.

"I suspect this criticism will first result in hearings to look at the Fed's conduct, not any legislative action," he said.

(Reporting by Mark Felsenthal; editing by Tim Ahmann)