As if the Dodd-Frank monstrosity weren’t bad enough, along comes another bad idea that falls under the category of no good deed goes unpunished. Mr. Frank has now proposed that the Reserve Bank presidents be removed from the FOMC. He apparently wants a more centralized central bank, centralized—guess where?—in Washington, D.C. If he gets his wish, it will destroy an important feature that has contributed to the Federal Reserve’s effectiveness.
As a reminder, the FOMC, the Federal Open Market Committee, is the group that makes monetary policy within the Federal Reserve. It is composed of the seven members of the Board of Governors plus the twelve Reserve Bank presidents. Similar centralizing legislation in the 1930’s stripped the regional representatives of seven of their twelve votes by allowing only five presidents to vote in any given year on a rotating basis. This was designed to give the Washington component a seven-to-five majority if the votes ever split along those lines. In addition, to give the Washington group more prestige, the title “Governor” was taken from the heads of the Reserve Banks and given to the Washington cohort.
The advantages of the present system are many. The twelve presidents, who participate fully in all the meetings whether they have a vote that year or not, have their own research staffs. They are not dependent on the one central (and excellent) research staff at the Board of Governors. Economics is not such an exact science that a variety of opinions is unimportant. Many important new approaches originate at the Reserve Banks rather than in Washington. Milton Friedman type monetarism at the St. Louis Fed comes to mind, as does rational expectations at the Minneapolis Fed.
Separate research departments bring a variety of economic theories, analysis, forecasting techniques, and conclusions to the FOMC table. Having separate boards of directors at the 12 Reserve Banks and their 24 branches also brings a wealth of on- the-ground grass roots information to the table through the presidents. Having regional directors drawn on a rotating basis from different sectors of the local and regional economies gives the FOMC much more timely information when it is needed most—at inflection and turning points in the economy. New “straws in the wind” almost always show up first in the anecdotal information gathered during those 36 monthly board meetings and other local meetings facilitated by the regional directors. Removing the presidents from the FOMC would remove or diminish the incentive for quality people to participate as local Reserve Bank directors and to work hard to bring in timely information. As it stands today, they know their voices and opinions will be heard; so they are willing to serve at virtually no pay.
Mr. Frank’s objection is that the twelve presidents are not elected or appointed by the president and confirmed by the Senate as are the Washington Governors. It is true that they are chosen initially by the regional head office directors, but those choices have to be approved by the Governors. During my day, the Governors required the Reserve Bank Boards to submit three candidates for the final choice to be made in Washington. To me, the selection of the Presidents seemed an important part of their role as Governors. The Presidents are approved in a manner that has been law for many decades and has worked well.
While FOMC debates rarely, if ever, come down to the Governors versus the presidents. If they did, the deck is already stacked in favor of the former. Decisions are arrived at by consensus with some deference given to the Chairman. In recent years it is probably true that more formal dissents have come from the Presidents than from the Governors, but I would argue that that is natural and a positive. Such transparency gives the public and markets a signal of what the minority view is and the rational for the dissent.
As an aside, I dissented three times from the Greenspan majority, twice in 1999 and once in 2002. In the latter case, I was surprised when a Governor joined me in dissent and accepted my rationale for the minutes.
I happen to believe that the FOMC’s performance during the financial crisis and its aftermath has bordered on heroic under difficult circumstances. I know others disagree, but I doubt that they would argue that its performance would have been better if the Presidents were removed. Doing so would be a solution without a problem and a bad idea.