And then there were four. US Federal Reserve vice-chairman Donald Kohn’s recent announcement that he will retire in June will bring the Federal Reserve Board down to four members.
While the law states that the board has seven governors, vacancies have become the norm in recent decades. Under George W. Bush, the Fed was at full strength for only about three years out of eight. Overall, the last few US presidents have made it clear by their actions that they place low priority on filling Fed vacancies other than that of the chairman.Chairman Ben Bernanke and his four colleagues, along with the presidents of the 12 district Reserve Banks, face two enormously complex and consequential sets of decisions. One has to do with the Fed’s exit from its hyper-expansionary monetary policies—a process that is just beginning. The other pertains to the post-crisis regulatory system—provided the US Congress keeps the Fed in that business.
First, consider the monetary policy exit strategy. In reacting to the impending calamity after Lehman Brothers failed in September 2008, the Fed cut interest rates to the bone and embarked on an unprecedented programme of “quantitative easing”. The latter basically meant aggressively expanding its balance sheet by buying assets and providing skittish banks with a veritable mountain of excess reserves. Most of this must be unwound.
So the Fed’s coming job is to slip deftly away from its current super-expansionary monetary stance by both draining bank reserves and raising interest rates. If the Fed tightens too slowly, we could be left with high inflation. If it errs by tightening too rapidly, we could fall back into recession. To say that the Fed’s navigators are in uncharted waters is a gross understatement. They don’t even know whether they are on land or at sea.
That said, the Fed is formulating exit plans, as Bernanke has made clear in recent testimonies and speeches. But he knows that the Fed will have to modify those plans many times and in many unpredictable ways as time goes by. Doing so adroitly will require both consummate technical skills and good seat-of-the-pants judgements. Yet, remarkably, once Kohn retires, the Federal Reserve Board will be down to just one member who is a trained economist.
Talent is often found in academia (example: Bernanke), but that is not the only source. In selecting nominees, the US President should be mindful of the fact that hawk-dove battles are starting to break out on the Federal Open Market Committee (FOMC) again. When it comes to exit, hawks clamour for faster action while doves counsel patience. Today’s FOMC is, on average, pretty hawkish. Obama will, I believe, want to create more balance.
The Fed’s second big task will be creating and adapting to the new financial regulatory system. The fate of financial reform is up in the air right now. One of the key elements under debate is the Fed’s role in the new regulatory regime.
So the Fed must be prepared for either of two challenging contingencies. If a major financial reform Bill passes, the Fed will likely have to reorganize itself and, in concert with other agencies, write scores of rules and regulations to implement the new regulatory framework. The other possibility is that no legislation passes. Since maintaining the status quo ante is unthinkable, the Fed would then have to think through and promulgate dozens of regulatory changes that fall within existing authority.
In either case, the Fed has a major regulatory job ahead of it. Economics will be useful here, too. But, specialization being what it is, the economists who would be most helpful on monetary policy will probably have little expertise on financial regulation. So it would be wise to nominate someone deeply experienced in banking or financial regulation.
The Wall Street Journal
Edited excerpts. Alan Blinder, professor of economics and public affairs at Princeton University, is a former vice-chairman of the Federal Reserve Board. Comments are welcome at firstname.lastname@example.org