The Federal Reserve System is in its centennial year, offering an opportunity for reflection on the Fed’s role in the economy, its organization, and its independence from the government. This discussion is hardly academic. Serious reevaluation of the Fed’s organization or leadership took place after the financial crisis of the 1930s and the inflationary excesses of the 1970s. The Fed’s scope and power grew with the passing of the Dodd-Frank Act in the aftermath of the 2007–09 financial crisis, and its dominant role in financial regulation has made it even more enmeshed with politics.
Against this backdrop lies another pressing reason to discuss the Fed’s mandate and organization — the imminent selection of a new Federal Reserve Board chairman and the likelihood that the president will appoint a new majority of Fed governors over the remainder of his term. In place of this serious discussion, the White House has allowed, if not orchestrated, a circus campaign of personality.
The nation deserves better. Discussion and debate of “what” the Fed should do and “how” it should be organized will be crucial for the success of its future leaders. And that discussion should precede the talk of “who” should lead the Fed.
New lending tools and a quantitative-easing program have significantly expanded traditional discount lending and Federal Reserve open-market operations. To taper or not to taper is the question on tongues in the United States and emerging economies alike. Likewise the Fed will lead a new regulatory architecture for bank and non-bank “systemically important financial institutions.” While the Fed has come up with technical policy responses to address the macroeconomic fallout of the crisis and President Obama and Congress emphasized technical rule-making and regulatory power in the Dodd-Frank Act, questions of the Fed’s judgment about the build-up of financial excesses and the costs of their unwinding remain. In addition, the question of whether the Fed’s mandate should be amended to include specific weight on maintaining financial stability is important. Finally, the expansion of the Fed’s scope has led and almost surely will continue to lead to a divergence of views among Fed officials about strategy and tactics for monetary policy and financial regulation.
These questions and changes yield three clear criteria for selecting a new Fed chairman — experience, independence, and leadership.
The chairman’s experience should include knowledge of monetary policy, the financial system, and links between financial imbalances and economic fluctuations. This experience should ideally be both in intellectual frameworks — how economic models work — and practical understanding – how financial markets work and financial practices evolve. Chairman Alan Greenspan’s practical knowledge of technology-fueled productivity growth in the 1990s allowed him to intuit a faster speed limit for the economy than traditional economic models suggested. The Fed benefited from Chairman Bernanke’s intellectual background in understanding financial crises, though it seems to have lacked adequate practical knowledge of the risks of imbalances in the financial system.
Federal Reserve independence — for the institution and its chairman — is critical. A classic study by Harvard economists Alberto Alesina and Lawrence Summers concluded that economies with independent central banks had lower inflation rates than countries in which independence was lacking. Today, an emphasis on independence extends to the stability of financial markets: Whether or not financial stability becomes part of the Fed’s official mandate, the central bank should be able to lean against financial imbalances without political interference. Independence is not just a de jure concept. In particular, the chairman’s political independence, in addition to the organization’s, matters: Fed chairman Arthur Burns’s close political ties with the Nixon administration likely contributed to excessively expansionary and ultimately inflationary pressure even in a formally independent Fed.
Finally, leadership skill is a key criterion by which a new Fed chairman should be judged. For the Fed, such skill must extend beyond articulating and communicating goals. The ability to forge consensus has always been an important attribute of the Fed chief — the Federal Open Market Committee as a group makes decisions about monetary policy, and the Board of Governors as a group makes decisions about extraordinary actions. But the expansion of Fed responsibility — particularly in unconventional monetary policy and financial regulation — has brought out a greater divergence of views among Fed officials. There is no going back to an imperial-chairman model.
The nation’s tepid economic recovery and legitimate concerns over the course of financial regulation make President Obama’s choice of the next Fed chairman — and other Fed governors — particularly significant. The president needs to communicate what he thinks the Fed’s role should be and what his criteria are for selecting its head. Experience, independence, and leadership should be key factors in guiding the president’s choice. If the president has other factors instead in mind, he should set them forth.
— R. Glenn Hubbard, dean of Columbia Business School, was chairman of the Council of Economic Advisers under President George W. Bush.