Federal Reserve documents 4 page

As financial experts understood well at the time, central banks can help end financial panics by lending cash to banks that are threatened by depositor runs, taking the banks’ loans and other assets as collateral. The classic prescription for central banks facing a panic was provided in 1873 by Walter Bagehot, the British journalist, economist, and longtime editor of the Economist magazine, in his short book Lombard Street: A Description of the Money Market. To calm a panic, Bagehot advised central banks to lend freely at a high interest rate, against good collateral, a principle now known as Bagehot’s dictum.

In a panic, depositors and other providers of short-term funding withdraw out of fear that the institution will fail and they will lose their money. Even a bank that is solvent under normal conditions can rarely survive a sustained run. Its cash reserves are quickly exhausted, and its remaining assets, including its loans, cannot be sold quickly, except at depressed prices. Thus, a run that begins because depositors and other providers of funds fear a bank may fail risks becoming a self-fulfilling prophecy. By lending freely against good collateral during a panic—that is, by serving as a “lender of last resort”—a central bank can replace the withdrawn funding, avoiding the forced sale of assets at fire-sale prices and the collapse of otherwise solvent institutions. Once depositors and other short-term lenders are convinced that their money is safe, the panic ends, and borrowing banks repay the central bank with interest. The Bank of England, the world’s preeminent central bank at the time Bagehot was writing, served successfully as lender of last resort throughout most of the nineteenth century, avoiding the regular bank panics that plagued the United States.

The United States needed a central bank to achieve its full potential as a global economic and financial power. But finding political support to do so remained challenging. To blunt opposition from midwestern farmers and others who feared that a central bank would serve eastern financial interests at their expense, President Wilson, together with Senator Carter Glass of Virginia and others, proposed creating a central bank that would be a truly national institution—responsive to national interests, not only the interests of financiers. To achieve that goal, Wilson and Glass supported an unusual structure. Rather than a single institution located in Washington or New York, the new central bank would be a federal system (hence the proposed name, Federal Reserve), with eight to twelve semiautonomous Reserve Banks located in cities across the nation. Each Reserve Bank would be responsible for a district of the country. Ultimately, twelve Reserve Banks would be chartered.*

As with earlier central banks in the United States and many central banks abroad, the Reserve Banks would, technically, be private institutions, albeit with a public purpose. Each would have its own president and a board of directors made up of private citizens, including commercial bankers, drawn from its district. Each of the Reserve Banks would be allowed some latitude to make decisions based on local conditions, including setting the interest rate at which it was willing to lend to commercial banks in its district. As Wilson observed, “We have purposely scattered the regional reserve banks and shall be intensely disappointed if they do not exercise a very large measure of independence.” The responsibility for oversight of the Reserve Banks and the System as a whole would be vested in the Federal Reserve Board, made up of political appointees based in Washington. The original Board included two administration officials ex officio: the secretary of the treasury and the comptroller of the currency (the Office of the Comptroller of the Currency, or OCC, is the regulator of nationally chartered banks). Congress accepted the plan, approving the Federal Reserve Act in 1913, and the Federal Reserve System began operations the following year—although not in time to stop another major panic, in 1914.

The innovative design of the Federal Reserve created a nationally representative and politically more

sustainable institution. But it also created a complex system without strong central oversight or clear lines of authority. For a time, the appropriately named Benjamin Strong, the head of the Federal Reserve Bank of New York, provided effective leadership. (As a rising young star in the financial world, Strong had been a protйgй of J.P. Morgan and had helped Morgan end the Panic of 1907.) But no one of equal stature stepped up after Strong’s death in 1928. The Fed proved far too passive during the Depression. It was ineffective in its role of lender of last resort, failing to stop the runs that forced thousands of small banks to close, and it allowed the money supply to collapse, the error emphasized by Friedman and Schwartz. Reforms under Franklin Roosevelt subsequently strengthened the authority of the Federal Reserve Board in relation to the Reserve Banks. These reforms also increased the Fed’s independence from the executive branch by removing the treasury secretary and the comptroller of the currency from the Board.

Today, the Board consists of seven members, appointed by the president and confirmed by the Senate to staggered fourteen-year terms. A new term opens every other year, and new members can be appointed to open seats at any time. For example, I was being considered for a seat whose term had less than two years to run. To stay longer (which I did not expect), I would have to be renominated by the president and reconfirmed by the Senate. The Board also has a chair and a vice chair, members who are nominated and confirmed to those leadership positions for renewable four-year terms.† Alan Greenspan, the chairman when I received Glenn Hubbard’s call, had served since 1987. The long, overlapping terms of members were intended to give the Board greater independence from political pressure, although this effect is diluted in practice because Board members almost never serve full terms.

To improve the performance of monetary policy, the Roosevelt reforms also created a new body, the Federal Open Market Committee (FOMC), as a successor to earlier internal committees. The FOMC would oversee the Fed’s buying and selling of government securities, the primary tool through which the Fed determined short-term interest rates and influenced the money supply. Since then, participants in FOMC meetings have included nineteen people—the seven Board members and the twelve Reserve Bank presidents. The chairman of the Fed’s Board is also, by tradition, the chairman of the FOMC. Although nineteen policymakers participate in FOMC meetings, only twelve have a vote at any given meeting: seven Board members, the president of the Federal Reserve Bank of New York, and four of the other eleven Reserve Bank presidents, with the votes rotating annually among the eleven. This convoluted design gives regionally appointed Reserve Bank presidents a voice in monetary policy decisions while also granting a majority to the politically appointed members of the Board.

In 1977, Congress set explicit objectives for monetary policy. It directed the Fed to pursue both “maximum employment” and “price stability.” These two objectives constitute the Federal Reserve’s so-called dual mandate.‡ The dual mandate both ensures the democratic accountability of the Fed’s unelected technocrats and forms the cornerstone of the institution’s independence. The Fed cannot choose its own monetary policy goals, which are set by law. But, within a framework of congressional oversight, the FOMC decides how best to achieve the objectives the law lays out. As one tool of congressional

oversight, the 1977 law required the Board to provide semiannual testimony about its objectives for the economy. The Humphrey-Hawkins Act of 1978, named after its sponsors, Senator Hubert Humphrey of Minnesota and Representative Augustus Hawkins of California, expanded this oversight by requiring the Fed chairman to testify twice a year (usually in February and July) before the Senate and the House to report on the state of the economy and the FOMC’s efforts to meet its dual mandate. These hearings have been known ever since as the Humphrey-Hawkins hearings.

Besides making monetary policy, the Federal Reserve also has responsibility for regulating parts of the financial system, including banks. It shares this role with other federal agencies, including the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation (FDIC), as well as with state regulators. The Board in Washington—not the FOMC or the Reserve Bank presidents—is vested with the Fed’s regulatory powers, including the authority to write rules that implement laws passed by Congress. The Reserve Banks are in turn responsible for supervising banks in their districts, applying the policies set in Washington.

While the authorities for monetary policy and financial regulation are clear, the governance of the Federal Reserve System remains complex. The Reserve Banks continue to have boards of private citizens who advise the banks on operational matters and tell the president of the bank their views on the economy. They do not, however, weigh in on banking supervision and regulation. These boards do help choose the Reserve Bank’s president—a rare example of a small group of private citizens helping to choose an official who wields government power. Ultimately, though, the Board in Washington has authority over the Reserve Banks; it must approve the appointment of presidents as well as the banks’ budgets.

MY APPOINTMENT WITH President Bush was just after lunch. I did not want to risk travel delays, so I took the train the evening before. Following instructions, I reported thirty minutes before my appointment to a side entrance of the White House. The administration did not want journalists to spot me. At the scheduled time, I found myself in the Oval Office, feeling a little overwhelmed. I had never been in the White House or met a president.

The president welcomed me cordially and said he had heard good things about me. He dutifully asked a few questions that obviously had been prepared by a junior economic adviser with an Econ 101 textbook at hand. I remember explaining how I would respond to a hypothetical change in the inflation rate. With that chore over, the president relaxed and asked me about myself, my background, my family. Finally, he inquired whether I had any political experience.

“Well, sir,” I said, “it won’t count for much in this office, but I have served two terms as an elected member of the Montgomery Township, New Jersey, Board of Education.”

He laughed. “That counts for a lot in this office,” he said. “Being on a board of education is thankless but it’s important service.” That exchange seemed to seal the deal. I met with others in the White House,

including Bush’s friend and adviser Clay Johnson and Josh Bolten, the White House deputy chief of staff. A few days later, I heard from Glenn that the president had enjoyed the meeting and intended to nominate me after all the necessary preliminaries had been completed. I agreed to accept the nomination if offered.

The preliminaries, it turned out, were not simple. Background checks took months. They included what seemed like endless paperwork to document where I had lived, whom I had associated with, where I had worked, where I had traveled, and how I had managed my finances since leaving college. I was interviewed by the White House personnel department and twice by FBI agents, who wanted to know if I had ever conspired to overthrow the government of the United States. Has anyone ever answered yes?

The vetting complete, the White House announced on May 8, 2002, that President Bush would nominate me. The process moved over to the Senate Committee on Banking, Housing, and Urban Affairs, the body with jurisdiction over nominees to the Fed. Fed staff prepped me for my as yet unscheduled confirmation hearing, and I spent hours with thick binders that detailed the Fed’s responsibilities and positions on various issues. I was warned not to comment in public on policy issues or to speak to the press. My nomination wasn’t controversial, and the goal was to keep it that way. My hearing before the Banking Committee, on July 30, lasted not quite an hour. The committee approved my nomination, and then, on July 31, the full Senate did so, without dissent. After it was all over, an advocacy group devoted to speeding up Senate confirmations sent me a T-shirt that read: “I survived the presidential appointee confirmation process.” In reality, my confirmation had been reasonably smooth.

Along with me, the Senate also confirmed Donald Kohn to a seat on the Board. Easygoing, thoughtful, and without ego, Don was a Federal Reserve System veteran. After receiving his PhD at the University of Michigan, he had begun his Fed career in 1970 at the Kansas City Federal Reserve Bank before moving, after five years, to join the staff in Washington. Over the years Don worked his way up to become the head of the Board’s Division of Monetary Affairs (a position created for him) and a close adviser to Chairman Greenspan. Don and his wife, Gail, were fitness buffs, with Gail an ardent rower and Don a hiker and bicyclist. Some reporters speculated that Don would serve as Greenspan’s proxy and would clash with me on issues like inflation targeting, of which Greenspan was a known skeptic. But in fact Don and I worked closely together and I trusted his judgment.

Don and I were sworn in by Chairman Greenspan on August 5, 2002. I won Greenspan’s coin toss, was sworn in first, and thus would remain forever senior to Don for official purposes, despite his thirty-plus years of experience at the Fed to my none. With Don’s and my arrival, the Board was at full strength, with all seven seats filled.

Once confirmed, I began to get to know the other Board members. Roger Ferguson, the vice chairman and an appointee of President Bill Clinton, and only the third African American to serve on the Board, had grown up in a working-class neighborhood in Washington. Quiet and unassuming but with a puckish sense of humor, Roger had earned undergraduate, law, and doctoral degrees from Harvard. He was working at the New York law firm Davis Polk when he met his wife, Annette Nazareth, who would go on

to serve as a commissioner at the Securities and Exchange Commission.

The job of the vice chairman can involve a good bit of administration—helping to oversee the Reserve Banks, for example. Roger did that well. He also played an avuncular role, checking on me periodically to be sure that I was settling in. The critical moment of Roger’s career at the Fed had come on September 11, 2001. When the planes crashed into the World Trade Center and the Pentagon, Roger was the only Board member in Washington. Under his direction, the Federal Reserve issued a statement affirming that it was “open and operating” and stood ready to serve as a lender of last resort if needed. He and a staff group set up a bank of telephones in a conference room near the boardroom and worked tirelessly to keep critical components of the financial system functioning. Roger could see the smoke rising from the Pentagon through the windows of his office. The Board’s quick response helped protect the economy by minimizing disruptions to the systems for making payments and transferring securities— the little-known but critically important plumbing of the financial system.

Two other Board members, Susan Bies and Mark Olson, had been bankers. Like me, both were Bush appointees. Sue, who had a doctorate in economics from Northwestern, had been in charge of risk management at First Tennessee, a regional bank. Mark had had a varied career that included being CEO of a small bank in Minnesota, working as a congressional staff member, and serving as a partner in the accounting firm Ernst & Young. In 1986, at age forty-three, he had been elected president of the American Bankers Association. Sue welcomed me in her warm and outgoing way, Mark in his understated Minnesota style.

Board member Edward (Ned) Gramlich, a lanky, white-haired former economics professor and dean from the University of Michigan, also made me feel at home. Ned had served briefly as a staff economist at the Board during the late 1960s and also as acting director of the Congressional Budget Office. He was appointed to the Board by President Clinton in 1997. Ned’s work as an academic economist covered a wide range of mostly microeconomic issues, and at the Board he tackled a diverse set of tasks, including serving as part-time chairman of the Air Transportation Stabilization Board, created by Congress after the 9/11 attacks to assist the airline industry. Ned also led the Fed’s efforts in community development and consumer protection.

After the welcomes, Don and I were sworn in a second time—in a formal ceremony in the two-story atrium of the Board’s headquarters (named for Marriner Eccles, Fed chairman from 1934 to 1948). The formal ceremony was legally redundant, but it was a nice event for our relatives and for the staff. Anna, Joel, Alyssa, and my parents all attended. I was amused and touched to see my small-town pharmacist father, brows furrowed in concentration, in earnest conversation with the renowned Greenspan.

In most countries, the head of the central bank is called the governor of the bank. At the Federal Reserve, the head of the central bank is the chairman, and members of the Board have the title of governor. (Since the Roosevelt-era reforms, its formal name has been the Board of Governors of the Federal Reserve System.) So I could now officially claim the appellation “Governor Bernanke.” Once, a

clerk at an airline ticket counter would ask me what state I was the governor of.

The formalities over, I settled into my new job and life as a long-range commuter. I rented a one-bedroom apartment in Georgetown, and most weekends drove my metallic blue 1998 Chrysler Sebring convertible the 186 miles each way to our home near Princeton. After brief discussions with Greenspan and Cary Williams, the Board’s ethics officer, I also kept, at least for the time being, the (unpaid) editorship of the American Economic Review.

On weekdays, I attended Board meetings and briefings, met with visitors, and traveled, including visits to Reserve Banks. On my first trip, Sue Bies and I went to Brownsville, Texas, to see the Dallas Reserve Bank’s community development efforts there. Yet I was feeling far from overworked. I talked to Roger Ferguson about it. Roger explained that it often took new governors time to find their niche, to determine the issues that mattered most to them.

To find my niche I had to contend with the Board’s committee system. Much of the work of the Board, outside of monetary policy, is done by committees of two or three governors, who then make recommendations to the Board as a whole. Seniority matters when it comes to assignments, which are made by the vice chairman in consultation with the chairman. I would have been interested in becoming more involved in bank supervision. But Roger headed that committee and the two bankers, Sue and Mark, completed it. I could have volunteered for more administrative jobs, but I had done similar work as department chair at Princeton and I wanted to be involved in policy. I ended up on the Committee on Payments, Clearing, and Settlement (which dealt with the plumbing of the financial system) and on the Committee on Consumer and Community Affairs (which handled consumer protection and community development), chaired by Ned Gramlich and with Sue as the other member. I also had administrative oversight of economic research—a natural fit. In that position, I would help found a new journal, the

International Journal of Central Banking, dedicated to publishing policy-relevant research from aroundthe world.

But I had come to Washington to be involved in monetary policy. Realistically, I knew that Chairman Greenspan—the “eight-hundred-pound gorilla” of the Federal Reserve, as Roger once called him—would have a predominant influence on the direction of interest rates. That didn’t seem unreasonable to me. After all, by the time I joined, Alan had sat in the chairman’s seat for fifteen years, and his decisions had earned him the sobriquet “the Maestro.” I could at best influence meeting-to-meeting rate decisions on the margin, I assumed. And in fact, I was less interested in each individual decision than in the broader framework in which policy was made. In that respect, it seemed to me, the Federal Reserve was behind the times.

Traditionally, monetary policy decisions had been shrouded in the so-called mystique of central banking—an approach that led the journalist William Greider to title his 1989 book about the Volcker Fed Secrets of the Temple: How the Federal Reserve Runs the Country. In a similar vein, Montagu Norman, the iconic governor of the Bank of England in the 1920s, 1930s, and early 1940s, purportedly

expressed his philosophy in the motto “Never explain, never excuse.” Various arguments have been advanced in favor of maintaining secrecy in monetary policymaking, but it seemed to me that one of the main reasons was the same one that keeps hot dog manufacturers from offering factory tours—it detracts from the appeal of the product if the public knows how it is made.

Secrecy cuts two ways. It can make central bankers seem more all-knowing and increase their short-term flexibility, but it can also confuse the public, wrong-foot markets, and fuel conspiracy theories. And, in a world of greater transparency and accountability throughout the public and private sectors, secretive policymaking at the Fed was beginning to feel anachronistic. I also believed that, on net, secrecy reduced the effectiveness of monetary policy. As Rick Mishkin and I had argued in our work on inflation targeting, monetary policy works better when the central bank communicates clearly with markets and the public.

I attended my first meeting of the Federal Open Market Committee on August 13, 2002, a little more than a week after my swearing-in. (The FOMC conducts eight scheduled meetings each year.) Over the weekend before, I studied the voluminous background materials prepared by the staff. There was the Greenbook, named for its green construction-paper cover, with data and analysis of both the domestic and international economies, as well as the staff economic forecast. The Bluebook reviewed financial market developments and compared the likely effects of alternative choices for monetary policy. Various staff memoranda and other documents added to the pile of paper. The staff’s forecasts, like those of private-sector forecasters, were as much art as science. They drew on a range of economic models developed over many years. But staff economists added substantial professional judgment to the mix, including their assessment of influences hard to capture in the standard data, like severe weather, possible changes in government tax or spending policies, and geopolitical developments.

The accuracy of both central bank and private-sector forecasters has been extensively studied and the results are not impressive. Unfortunately, beyond a quarter or two, the course of the economy is extremely hard to forecast. That said, careful projections are essential for coherent monetary policymaking, just as business plans and war strategies are important in their spheres.

Greenspan was known for his economic forecasting skills, having run a successful consulting firm, Townsend-Greenspan & Co., before his time in government. He put less weight on computer-simulated models and instead practiced an idiosyncratic, bottom-up style of forecasting. He regularly reviewed hundreds of small pieces of information. In my own thinking, I tended to emphasize developments in broader economic indicators—the forest rather than the trees—but I appreciated that the chairman’s approach could sometimes yield interesting insights that more standard analyses might miss.

On the morning of the meeting, breakfast was served in the top floor of the 1970s-era Martin Building, behind the Depression-era Eccles Building. (William McChesney Martin served as Fed chairman from 1951 to 1970.) I joined the breakfast to meet and talk with the Reserve Bank presidents. I knew some of them from my days as an academic and Federal Reserve hanger-on. FOMC members mixed amiably, with little tendency to form cliques based on their policy views. It wasn’t like a high school cafeteria. The

hawks (shorthand for policymakers who tended to worry more about inflation) did not sit at a different table than the doves (policymakers who tended to worry more about growth and employment).

Ten or fifteen minutes before the start of the meeting, participants began to filter toward their assigned places at the mahogany and black granite table in the Eccles Building’s boardroom. The boardroom is high-ceilinged and elegant, fifty-six feet long, with high draped windows facing Constitution Avenue. On one wall, a large map of the United States shows the borders of the twelve Reserve Bank districts.

Besides policymakers, four or five staff members with speaking parts also sit at the table. The head of the Open Market Trading Desk at the New York Fed, which manages the Fed’s purchases and sales of securities (which are done in the “open market”) and maintains frequent contact with market players, would typically begin the meeting by summarizing key financial developments. When I joined, the desk chief was Dino Kos. The directors of the Board’s Division of Research and Statistics (Dave Stockton) and its Division of International Finance (Karen Johnson), or their top deputies, would follow with presentations on the staff’s U.S. and international economic forecasts. Later in the meeting, the director of the Division of Monetary Affairs (Vincent Reinhart, heir to the position created for Don Kohn) would present the policy options as explained in the Bluebook. Collectively, the three Board division directors wielded considerable influence. My Princeton colleague Alan Blinder, who served as Board vice chairman in the mid-1990s, nicknamed them “the barons.”

Greenspan’s chair, still empty at a few minutes before the start of the meeting, was at the midway point of the twenty-seven-by-eleven-foot two-ton oval table, facing the main entry to the room. To the chairman’s right sat the president of the New York Fed—by tradition also the vice chairman of the FOMC —Bill McDonough. A former banker from Chicago, McDonough had been the New York Fed president since 1993. Ferguson, the Board vice chairman, sat on Greenspan’s left. The two most junior members, Kohn and I, were squeezed into corners of the table, out of the chairman’s line of sight. About thirty-five staff members from the Board and the Reserve Banks took their seats around the room.

At precisely 9:00 a.m., a door next to the fireplace opened, and Chairman Greenspan emerged from his office and strode to his seat. The room quieted. Greenspan sat and organized his papers. In one sentence, he welcomed me and Don, then called for the staff presentations.

Greenspan had met with me over breakfast before my first meeting to make sure that I understood how FOMC meetings were organized. First on the agenda were the staff briefings on financial markets and the economic outlook, followed by questions from the nineteen Board members and Reserve Bank presidents. The “economic go-round” came afterward. Each of the participants spoke for four or five minutes about the economic outlook. The Reserve Bank presidents typically reported first on developments in their own district, then turned to their views of the national economy. Governors usually spoke later, followed by the vice chairman (McDonough) and, finally, Greenspan. At one time, the nineteen presentations had been at least partly extemporaneous. Unfortunately for the quality and spontaneity of the discussion (although good for transparency), the FOMC, in response to demands by Representative Henry Gonzбlez, then-head

of the House Financial Services Committee, had agreed in 1994 to release full meeting transcripts after five years. Since then, most participants had taken to reading prepared statements.

I WAS JOINING the Committee at a complex moment for the economy. The country was in the early stages of recovery from a recession (a period of economic contraction) that had lasted only eight months, from March to November 2001. (Once output begins to increase again, the economy is said to be in recovery and the recession over, even if the jobs and output lost have not been fully regained.) Recessions can be triggered by many causes, or combinations of causes. The 2001 recession had followed the collapse of the dot-com bubble and a sharp decline in the overall stock market; in the middle of it, the economy received a further blow from the 9/11 attacks.

Date: 2016-04-22; view: 772