Why Bank Presidents Could Rule the Fed Next Year

By: John_Mauldin

There’s a possibility the Fed will shrink to three—or even two—governors next year. I wrote about this in great length in my latest Thoughts from the Frontline, and I highly suggest you give it a read.

Among other things, the missing governors could have an enormous impact on monetary policy.  But before we delve into the implications again, I must explain the Fed’s Byzantine organizational scheme.

How the FOMC Works

Monetary policy—interest rates and the like—issues from the Federal Open Market Committee. The FOMC comprises:

• All seven Board of Governors members

• The president of the New York Federal Reserve Bank

• Four of the other 11 Fed Bank presidents, who rotate through one-year terms.

So on this committee of 12, the politically appointed governors have seven votes, outweighing the five privately appointed bank presidents. Except when there aren’t seven governors, as is the case now and probably will be well into 2018, at least.

In practice, this voting edge rarely matters because Fed chairs work hard to build consensus on the FOMC. They don’t like dissenting votes. I can’t recall any situation where the Board of Governors and the bank presidents seriously disagreed.

But it could happen. And if it happens in 2018, the bank presidents will have the upper hand.

A Looming Clash Between Academics and Business Leaders

Just to make the situation even murkier, two of the five bank presidents who will be on the FOMC in 2018 are currently unknown.

New York Fed President William Dudley will be leaving by mid-year. The other four will be the Atlanta, Cleveland, Richmond, and San Francisco presidents; and the Richmond post is presently vacant.

My good friend and fishing buddy Bob Eisenbeis of Cumberland Advisors, a former Fed economist, pointed out in a recent analysis that once Yellen leaves, the Board of Governors will have only one doctorate-holding economist, Lael Brainard (who will quite likely be leaving the board within a year – see below). Marvin Goodfriend will be another when he is confirmed.

Goodfriend is often cited as a conservative economist. I am not sure how that squares with his open support of negative interest rates. Bob Eisenbeis also just penned a piece on Marvin Goodfriend. There is no question Marvin is qualified. Here’s Bob:

He [Goodfriend] brings a lot to the table. First, he is a first-rate economist with a truly international reputation. He has held visiting, consulting, and evaluative positions at numerous central banks and international organizations including the Riksbank (Sweden), Bank of Japan, De Nederlandsche Bank (Amsterdam), Bank of India, Norges Bank (Norway), Swiss National Bank, ECB, Saudi Arabian Monetary Agency, and IMF, just to name a few. Additionally, he has been actively involved with the Federal Reserve System itself since joining the faculty at Carnegie Mellon in 2005 and has been a member of the Shadow Open Market Committee. So he knows central banking and the workings, culture, and staffs of the Board of Governors and the Federal Reserve system more generally; and he has participated in policy evaluations of the performance of several non-US central banks.

Second, his academic credentials are extensive. He has published in the best journals in both the areas of monetary policy and international trade. He has served on the editorial boards of most of the major economics journals and is a research associate at the National Bureau of Economic Research.

Third, when it comes to policy, he understands the models employed. During Marvin’s long tenure at the Richmond Fed, the policy positions taken by then President Broaddus evidenced a concern by both men for inflation and keeping it low. This belief is also reflected in some of Marvin’s writings and transcends his time at the Richmond Fed. However, as was noted in a recent WSJ article summarizing his likely approach to policy, there are also times when one must also be concerned about deflation and how policy might best be conducted in a world where interest rates are zero or perhaps even negative. For example, Marvin proposed policy options for dealing with the so-called “zero lower bound” problem in 2000, long before it became a real issue in the wake of the financial crisis.

Back to the FOMC. The Atlanta, Cleveland, and San Francisco banks all have economists at the helm. Eisenbeis thinks the New York and Richmond Fed Banks will appoint economists as well.

How Does That Two-Way Split Matter?

So we are setting up a situation where the 2018 FOMC will be split along two axes: governors/bank presidents and economists/non-economists.

As I have mentioned before, the economics profession hasn’t exactly covered itself in glory in the wake of the financial crisis.

Briefly, I think academic economists have become too enamoured of their models, which fail to account for the modern economy’s vast complexity and the often-irrational decisions people make.

I would much prefer to have the Federal Reserve System led by experienced business leaders and others with more practical experience in the economy the Fed helps manage. I think we would all be better off.

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