Host of issues converge to bring about scrutiny of NY Fed pick

Host of issues converge to bring about scrutiny of NY Fed pick
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The New York Federal Reserve Bank has announced that it has chosen John Williams, currently the president of the San Francisco Fed, as its next president.

The choice of Williams has generated an unusual degree of interest, for three reasons. First, the N.Y. Fed president is first among peers. Unlike the other 11 presidents of the Federal Reserve Banks, the N.Y. Fed president has a permanent seat on the decision-making Federal Open Market Committee.

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Second, with four of the seven seats on the Federal Reserve’s Board of Governors empty, the Trump administration has an unusual opportunity to reshape the Fed’s leadership. The Board of Governors members serve 14-year terms at the Fed’s headquarters in Washington, D.C.

 

Since the N.Y. Fed president is not chosen by the president, the choice has special resonance at this moment.

Third, related to the second point, progressives have lobbied hard for a N.Y. Fed chief who would not be a white male and would not be overly sympathetic to Wall Street.

The N.Y. Fed’s role reflects the bank’s location right in the heart of Wall Street. The N.Y. Fed implements the Fed’s open market operations, buying and selling securities from the largest banks. It also supervises these banks.

In past crises, the N.Y. Fed has played a crucial role in keeping lines of communication between the Fed and the financial industry open.

While the president nominates and Congress confirms Board of Governors members, presidents of the Federal Reserve banks are chosen by members of each bank’s board of directors. This opaque process has led to sharp criticism.

It is something of an anachronism, stemming from the original vision of the banks as representing the banking community in each of the Fed’s 12 districts. However, the two N.Y. Fed board members in charge of the selection process say that they made great efforts to interview a diverse pool of candidates.

John Williams certainly is a Fed insider. He has worked at the San Francisco Fed since 1992, with only a one-year stint at the Council of Economic Advisers in 1999-2000. The selection committee put great emphasis on hiring someone who could immediately master the intricacies of the N.Y. Fed job.

Inside experience may be a double-edged sword: It will allow Williams to get up and running quickly, but it also risks that Fed “groupthink” may not be challenged, a point made by former Fed economist Andrew Levin in the New York Times.

Williams’ competence in monetary policy issues is not in dispute. He served as vice president in charge of economic research at the San Francisco Fed. He has written widely in top professional journals. His expertise in economic analysis is particularly crucial with a Fed chairman, Jerome Powell, who is not a professional economist.

Powell, a former investment banker, has Wall Street savvy and some history at the Fed; Williams could be a prized adviser.

Williams’ policy views are nuanced. He has recently made two major contributions to the Fed’s policy debate. First, he has co-authored studies suggesting that the natural rate of interest has fallen significantly since the financial crisis.

In practical terms, this means that the Fed will not need to raise the federal funds rate, the interest rate it influences, to anything near the 5.25 percent that prevailed in 2007.

Second, Williams has suggested that the Fed allow inflation to exceed its current 2-percent target in the aftermath of periods of lower inflation. That would mean now. This important tweak to the Fed’s approach could reduce the chances of extremely low inflation coupled with high unemployment and a sluggish economy.

It would also reduce the chances of actual deflation. The U.S. experience with deflation in 1929-31 and Japan’s experience from 1998 until recently suggest that deflation not only deepens economic crises, it can be a quicksand that is extremely difficult to get out of.

Although progressives may be disappointed that John Williams is another white male leader and a Fed insider, they could take some heart from the fact that he served in the Clinton administration’s Council of Economic Advisers, and is not a Wall Street banker. He clearly worked well with Janet YellenJanet Louise YellenTrump nominates former Fed economist to central bank's board On The Money: Trump may impose 0B in China tariffs as soon as next week | Trump nixes federal worker pay raise | Biz groups push for deal with Canada | Trump threatens to leave WTO Trump says he doesn't regret picking Powell to lead Fed MORE.

Conservatives can take heart that Williams’ doctoral thesis adviser was the celebrated conservative economist John Taylor. Williams is reputedly able to work well with people across the political spectrum, an unusual characteristic in these polarized times.

The controversy about the selection process underlines the need for further discussion. The Dodd-Frank Act stipulated that members of the Board of Directors of Fed banks that are themselves affiliated with regulated banks may not vote on the choice of president of the Fed banks. This was an important change, but hardly adequate.

The Fed was explicitly created to be independent of politics under the assumption that politicians would be too tempted to manipulate monetary policy to create economic conditions favorable to their re-election.

Delegation to an independent body does seem to have been an ingredient for the relatively low inflation in the U.S. compared to other advanced economies since the establishment of the Fed. But the current selection process just seems too inbred and too closed for a 21st-century democracy.

Progressive groups focus on unemployment. The "Fed Up" campaign has advocated keeping monetary policy stimulus in place longer to drive unemployment lower. Fed officials, including John Williams, have favored raising the federal funds rate in small steps to avoid stimulating the economy too much and generating a large burst of inflation that could prove difficult to control.

There is a good deal of evidence suggesting that the economy is much less prone to inflationary episodes now than it has been in the past. Both former Fed Chair Janet Yellen and John Williams have been willing to consider policies that would allow a small increase in inflation in the hopes of bring workers who had given up back into the job market.

However, it seems important not to put too much of the burden of fighting unemployment and poverty on the Fed. Monetary policy is not a cure-all. Many other factors, such as tax policy, social programs, labor law and minimum wage legislation have a role to play.

The Fed can and should avoid killing off the recovery prematurely, but it cannot improve the plight of poorly-paid, underemployed workers by itself.

Evan Kraft specializes in the economics of transition, monetary policy and banking issues as a professor at American University. He served as director of the research department and adviser to the governor of the Croatian National Bank.