How the Fed's Arcane Structure Could Protect Monetary Policy

Daily Herald (Arlington Heights, IL), October 8, 2017 | Go to article overview

How the Fed's Arcane Structure Could Protect Monetary Policy


Byline: Jeanna Smialek Bloomberg

To the casual observer, the Federal Open Market Committee September meeting in Washington might have looked like any other. But when San Francisco's John Williams, Minneapolis's Neel Kashkari, and the other regional Fed presidents took their seats at the big oval table, an historical anomaly glared back from the other side.

In a rare alignment of events, the five voting presidents outweighed Board of Governors voters, who include Federal Reserve Chair Janet Yellen. It's a gap that opened up earlier this year and which looks poised to persist, at least for the near future.

This matters. There are 12 Fed presidents, chosen for five-year terms by their regional boards. The seven governors are appointed by the president and confirmed by the Senate for staggered 14-year terms. Because of the retirement of Daniel Tarullo, the governor informally tasked with heading financial regulation, the Fed board has been down to four voters since May, and with Vice Chairman Stanley Fischer leaving, it's possible the number could be down to three by the next FOMC meeting.

It looks likely that Randal Quarles, Trump's first nominee, could be confirmed before that, holding the governors steady at four. The regional contingent, meanwhile, remains near full force, with only the Richmond Fed currently looking for a new president.

The Fed's arcane structure, born of populist angst, may protect monetary policy from massive upheaval.

At a time when the current occupant of the Oval Office could choose at least four new governors, the power of the regional presidents amounts to a stabilizing backbone and bastion of independence in an era of transition at the Fed. Yellen, Lael Brainard, and Jerome Powell are the holdouts on the board in Washington, and President Trump isn't expected to reappoint Yellen when her term ends in February.

Thus it could fall to the Fed's arcane system, born of populist angst, to protect monetary policy from massive upheaval. The current state of affairs underscores how this uniquely American setup, erected in stages beginning in the years before World War I, remains relevant a century later, even though many of the functional duties of the world's most powerful central bank have changed.

"The regional banks are a bizarre set of entities," says Aaron Klein, a Brookings Institution fellow who studies the central bank. "In some ways the mission of the regional system is to bring in diverse viewpoints that challenge the political board."

While two of the board spots seem to be earmarked for fairly conventional picks -- Trump has nominated Quarles, a former investment banker and Department of Treasury official, as financial regulation czar, and Marvin Goodfriend, a professor of economics at Carnegie Mellon University, is being considered for nomination as a governor -- there could be major changes because so many positions remain open.

Fortunately for the Fed, which the world counts on for stability and predictability, its structure means institutional knowledge and independent voters will smooth over any Fed-related tumult in Washington. This is no accident. Some Fed officials like to say that if you built the central bank from scratch today, it'd be done differently.

And yet that assertion is often followed by a rhetorical shrug: It's an odd setup, but it works, so why change it?

Odd it is. The Fed is split into 12 regional branches, each organized like a private corporation, that unevenly divide the country. The San Francisco branch services a third of the nation, for instance, while Missouri hosts two branches, one in Kansas City and another in St. Louis. Even this patchwork quilt of a system wasn't knitted until 1913. Before that, public distrust of big government and East Coast financiers-think farmers vs. bankers-doomed two earlier efforts to create a permanent U.S. central bank. …

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