Four Ways to Reform the Fed
The expanding responsibilities of the U.S. Federal Reserve have prompted numerous calls for reform, ranging from intrusive audits to outright abolishment. I disagree with most of the proposals, but I do believe that the central bank would benefit from some changes -- four, to be exact.
First, a bit of context. In a recent essay that will appear in the Journal of Economic Literature, I explore four aspects of the Fed's structure: to what extent elected officials set the bank's objectives and hold it accountable; how the Board of Governors in Washington D.C. oversees the twelve regional Federal Reserve banks; what role the presidents of the regional banks play in the making of monetary policy; and how the functions of the various parts of the Fed system have changed over the past few decades. The inspiration came from an excellent new book, "The Power and Independence of the Federal Reserve," in which the legal scholar Peter Conti-Brown describes the historical forces that have shaped the idiosyncratic and multi-faceted institution, with its ostensible independence and responsibilities ranging from helping banks move money to managing the economy and overseeing the financial system.
My analysis leads me to four recommendations for possible reforms.
1) Congress should more clearly define the Fed's goals for monetary policy, bank supervision and financial stability.
For all the added responsibilities that Congress has given the Fed in recent years, it doesn't provide much guidance on objectives -- as anyone who listens to the questions elected officials ask at Chair Janet Yellen's semi-annual congressional testimonies will quickly realize. Even in the core area of monetary policy, it's not clear how the central bank should weigh its dual mandates -- price stability and maximum employment -- when the two are in conflict. Greater clarity would make the Fed more effective and provide protection if, say, a future president tried to interfere with its policy decisions.
2) The public should have a lot more visibility into how the Board of Governors oversees regional Federal Reserve banks, particularly with respect to appointing the banks' presidents.
The Fed is an odd hybrid, in which the Board of Governors has vast authority to ensure that the privately owned reserve banks act in the public interest (as opposed to in the interests of directors, many of whom are appointed by commercial banks). The Board, for example, has veto power over the appointment and re-appointment of the banks' presidents. Yet it exercises its powers largely in the shadows. The public would be much more confident in the Fed’s basic structure if it had a lot more information about the board's deliberations and decisions.
3) The president of the New York Fed should not vote on monetary policy.
The president of the New York Fed is the only regional reserve bank head with a permanent vote on the Federal Open Market Committee, which sets monetary policy. This creates a potential conflict of interest, because the New York Fed and its staff also play a critical and necessary role in facilitating communication between the central bank and Wall Street. The obvious solution is to strip the New York Fed of its monetary-policy vote -- a change that could arguably be accomplished without further legislation. The other reserve bank presidents should retain their votes (which they exercise on a rotating basis). These votes help assure the public that the policy-making committee is considering a wide range of non-D.C. and non-Wall Street perspectives before making decisions.
4) There should be a public conversation about changing the structure of the Fed to better reflect its functions and objectives. Should it become a unified public entity, and if so what would the policy-making Open Market Committee look like?
The Federal Reserve System has become a lot more centralized over the past few decades. It began as a collection of twelve private institutions that provided financial services for regional banks and for the federal government. Now, functions such as payment processing are concentrated at specific regional reserve banks, and a much larger share of staff is dedicated to supervision and monetary policy. Does this mean that the Fed's hybrid structure, in which a public Board of Governors oversees a system of distinct private regional reserve banks, is obsolete? If the Fed instead became a single independent government entity, how could it still ensure that monetary policy is informed by a diversity of voices?
My recommendations differ significantly from Conti-Brown's, who suggests giving the U.S. president appointment powers over some staff members at the Board of Governors and greatly reducing the role of all regional Fed presidents. My hope is that our views will be the beginning of a conversation -- a crucial one, given how the Fed's structure can influence decision-making at what is arguably the most powerful economic institution in the world.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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