The Fed Is Weird. Get Over It.
The Federal Reserve System is a strange, ungainly beast. Its strangest and ungainliest appendages are the regional Federal Reserve Banks, 12 technically private institutions scattered unevenly across the nation. The Federal Reserve Bank presidents are chosen by boards of local citizens -- although not, since the Dodd-Frank Act, by local bankers -- and are paid on a scale that actual government officials below the level of U.S. president can only dream of (unless you count state-university football and basketball coaches as government officials).
Yet these well-remunerated private citizens get to help set the nation’s monetary policy. The New York Fed president has a permanent say in the deliberations of the rate-setting Federal Open Market Committee; the other 11 presidents rotate through four voting spots -- and they can come to the meetings even when they don’t vote.
Is this weird? Absolutely (Texas Congressman Wright Patman once called the Fed "a pretty queer duck"). Is it of dubious constitutionality, as lawyer/historian Peter Conti-Brown argues in a paper that he presented at the Brookings Institution Monday? Probably. Is it a bad system that has reduced the effectiveness of the Fed and public trust in it, as Conti-Brown also argues? I’m not so sure about that.
In his paper, which is great on the Fed history even if you disagree with the conclusions, Conti-Brown argues that the Fed would be more effective and more trusted if some or all of the Federal Reserve Bank presidents were appointed by the president and approved by Congress -- or, better yet, if the Federal Reserve Board appointed them.
In his response to Conti-Brown at the Brookings event, former Philadelphia Fed President Charles Plosser argued that this was a solution in search of a problem. None of the Fed’s big historical failures -- the Great Depression, the Great Inflation of the 1970s, and the 2007-2008 financial crisis -- could really be attributed to the appointment process at regional reserve banks, Plosser said.
I’m not sure he’s right about the Great Depression. The Federal Reserve Bank presidents were a big cause of the Fed’s dawdling in the early 1930s; in 1935 Congress rewrote the Federal Reserve Act to shift the balance of power away from them to the Federal Reserve Board in Washington. But his bigger point that it isn't clear what Conti-Brown’s proposal would fix seems right. In fact, I could think of a couple of things it would mess up.
The first, which got a lot of discussion Monday at Brookings, is the Fed’s status as one of the last islands of technocratic, largely nonpartisan policy making in Washington. Technocracy and nonpartisanship aren’t always positives; they can be used to disguise interests and power relationships. Also, the technocrats can be terribly wrong, as they were in the lead-up to the financial crisis (not that the politicians were any righter). But at a time when Congress is riven by the deepest partisan divide in more than a century and even the deliberations of such supposedly technocratic agencies as the Securities and Exchange Commission and the Federal Communications Commission have become increasingly hijacked by party-line disputes, the tone of discourse within the Federal Reserve System stands out as a refreshingly civil and thoughtful exception. The tone of discourse ABOUT the Federal Reserve System is another matter, of course -- but changing the appointment process for Federal Bank presidents almost certainly wouldn’t change that, while it might endanger the culture within the institution.
The second thing is that having the Federal Reserve Bank presidents on the FOMC increases the diversity of opinion and economic methodology on the committee. It doesn’t increase it by much, I’ll admit. But any increase helps, thanks to what the University of Michigan’s Scott Page calls the Diversity Prediction Theorem. This is the simple mathematical truth that “given a crowd of predictive models, collective error = average individual error - prediction diversity.”
The unique appointment process for Federal Reserve Bank presidents brings people into policy making who might not be willing to take conventional government jobs. It then gives them the freedom to entertain new ideas and diverge from the consensus in a way that would be much harder for Federal Reserve Board employees to do. And it does this within a structure that still leaves the political appointees in Washington with a clear power advantage that makes early-1930s-style deadlock unlikely. That seems more like a desirable feature than a bug.
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