This Week in Fed Reform
Rep. Barney Frank (D-MA) has a new bill to trim the membership of the Federal Open Market Committee (FOMC), the rate-setting arm of the Federal Reserve. WSJ:
The bill would remove from the 12-member policy-setting Federal Open Market Committee the five members who represent regional Fed banks. Only the seven-member board in Washington, which currently has two vacant seats, would get to vote on interest rates. The congressman said this would make the Fed more democratic and increase “transparency and accountability on the FOMC” by eliminating those officials who are effectively picked by business executives. (Read the bill.)
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Analysts said Frank’s new proposal could hurt the Fed’s independence from Congress. Dan Greenhaus, analyst at Miller Tabak & Co., said the move is “one step closer to having monetary policy dictated by the Congress.”
“Analysts” say lots of things. I took several steps towards Congress myself when I walked eastward toward the Capitol after breakfast this morning, but since I’m 3,000 miles away I’m still not very close. Plus, even if they haul me in front of some oversight committee, I won’t necessarily have to do everything they want me to do. Indeed, I’m likely to get very different instructions from different members, making it hard to know which policies I should consider to have been dictated by Congress rather than within my officially recognized discretion.
So I’m not sure Frank’s bill would put us one step closer to Congressional control of monetary policy. But it is one step closer to having monetary policy dictated by an agency whose composition is not baldly unconstitutional. And it is one step closer to making the FOMC less independent from the President, who is charged with the constitutional responsibility to take care that the laws be faithfully executed and who should maybe therefore have a say in selecting the officials who will do the actual executing. (The regional bank reps on the FOMC are selected by private citizens (business executives) who are board members of the regional reserve banks; members of the Fed Board of Governors are appointed by the President of the United States subject to Senate confirmation.) You’d think that unitary-executive-loving Republicans would be climbing over themselves to support this bill.
I’m in no position to say what bureaucratic arrangements will lead to optimal monetary policy from the Fed. But it seems to me there are real and appropriate concerns with the lack of accountability at the Fed, and one way to begin to address those concerns would be to replace that portion of the FOMC that is 100% unaccountable to any person, office, or entity of the United States government with something at least as accountable as the Board of Governors. Like, say, the Board of Governors. Conveniently, the Board of Governors already constitutes part of the FOMC and is appointed in compliance with the Constitution.
Meanwhile, Sen. Richard Shelby (R-AL) continues to block President Obama’s nomination of Nobel-prize-winning economist Peter Diamond to the Fed Board on the grounds that he does not have enough experience.
Hat tip Niklas Blanchard.
More of my occasional forays into Fed-blogging here.
The FOMC Is about 42% Unconstitutional
The Federal Open Market Committee (FOMC) is powerful, weird, and about 42% unconstitutional.
Powerful. The FOMC is a core policymaking body of the U.S. Federal Reserve System. It is the part of the Fed responsible for manipulating interest rates (which it does by means of “open market operations,” i.e., buying and selling Treasury bonds to modulate the supply of cash in the economy). Basically, in conjunction with the Fed’s Board of Governors, it is the Mother Brain of the U.S. economy.
Weird. The weirdness of the FOMC comes in part from its abstruse subject matter and the borderline alchemical vibe of its operations (see previous). But it is also structurally weird. The FOMC is a strange public/private hybrid whose twelve (12) voting members comprise the seven (7) members of the Fed’s Board of Governors plus a rotating contingent of five (5) presidents of the regional Federal Reserve Banks. Members of the Board of Governors are appointed by the President of the United States, subject to approval by the Senate. The presidents of the regional Reserve Banks, by contrast, are chosen by the Banks’ boards of directors, subject to approval by the Board of Governors. (Background here.) Among the vast and varied agencies wielding any measure of power in the federal government, this arrangement is unique—weird, even. And it is patently unconstitutional.
It is worth pausing to let the weirdness sink in. A major portion of the monetary policy of the United States—possibly the singlemost important lever of public control of the economy—is conducted by a committee of individuals, a large fraction (5/12) of whom are not even officers of the United States government. And the fraction is often even greater in practice due to routine vacancies on the Fed Board. When the Board operates with two vacancies, as it did for much of the last couple of years, it occupies only five seats on the FOMC, and the denominator of FOMC votes drops to ten—five from the Board, five from the Banks.
Unconstitutional. Now, you might think this mix creates a sensible balance on the committee, or you might think it an affront to democracy. Either way, it is a clear violation of the Article II Appointments Clause, which provides:
The President . . . shall nominate, and by and with the advice and consent of the Senate, shall appoint ambassadors, other public ministers and consuls, judges of the Supreme Court, and all other officers of the United States, whose appointments are not herein otherwise provided for, and which shall be established by law: but the Congress may by law vest the appointment of such inferior officers, as they think proper, in the President alone, in the courts of law, or in the heads of departments. (U.S. const. art. II, § 2, cl. 2.)
The Constitution allows for only two ways of appointing officers of the federal government. First (the default): an officer may be appointed by the President with Senate approval. Or second: where lesser offices are concerned, an officer may be appointed by the President, the courts, or department heads without Senate approval.
Voting members of the FOMC are top-level policymakers in a federal government agency; as such they exercise discretionary powers that distinguish officers of the United States from mere civil servants. The five members representing the regional Reserve Banks (“regional members”) are not appointed by the President or confirmed by the Senate and therefore do not satisfy the default appointment criteria. But nor are those regional members appointed by the President, courts, or the head of any department or agency of the federal government. They are appointed by the private and independent boards of directors of the regional Reserve Banks. So they also fail to satisfy constitutional criteria for appointment of inferior officers.
And there you have it. Five of twelve seats violate the Appointments Clause, making the FOMC just about 42% unconstitutional.
Quantitative Easing Demystified
As if people need to be reminded that they, we, don’t understand how the Federal Reserve conducts U.S. monetary policy, the term “quantitative easing” periodically surfaces to do exactly that. Basically QE consists of the Fed buying Treasury bonds to pump money into the economy. Which, coincidentally, also describes what the Fed normally does to control interest rates. Karl Smith, guest-blogging for Ezra Klein, explains:
Most people are probably pretty familiar with the idea that the Fed raises or lowers interest rates. Yet, how does it do that?
Well suppose the Fed wanted to lower interests rates. The Federal Open Market Committee – which Ben Bernanke heads – issues orders to the open market desk.
Traders at the open market desk are told to start buying bonds. As they do bonds go up and price and the yield or interest rate goes down. The traders are ordered to continue buying until the interest rate hits the committee’s target and then stop.
However, currently interest rates on short-term bonds are basically zero. What are the traders to do? Well, consistent with their orders they simply stopped, and the market halted where it was.
Now, the Fed is issuing a new kind of order. It used to say keep buying until you hit a target interest rate. Now it is saying keep buying until you have spent $75 billion per month. The traders will begin buying as ordered, and instead of stopping when they see a certain interest rate, they stop once they’ve spent a certain amount of money.
Economists like to think in terms of prices and quantities. Usually the orders from the FOMC come in the form of prices, in this case the price is called the interest rate. Now the orders will come in terms of quantities. This is why the whole thing is called quantitative easing. It is a quantity target instead of a price target.
Otherwise, it is the same.
Neither Intelligible, Nor a Principle
The Fed’s “dual mandate” to promote maximum employment and curb inflation is problematic. It’s sort of like telling someone to work as much as possible and sleep as much as possible. The two goals counteract one another, and there’s a whole lot of middle ground between them. Matt Yglesias dreams of a better way:
This is pie-in-the-sky, but I think that if Congress wants to get serious about supervising the Fed better what they ought to do is scrap the “dual mandate” in favor of something clearer. The nature of the dual mandate is that it’s impossible to say if the Fed is meeting its mandate, and thus impossible to hold anyone accountable. As an alternative, Congress could set a statutory nominal GDP trend target or a price level trend target and hold the leadership of the Fed accountable based on how good a job they do of hitting the target.
One thing the current system shows you is that it doesn’t take much for a statutory mandate to satisfy the Supreme Court’s “intelligible principle” standard (though I don’t believe the Supreme Court has specifically addressed the Fed’s mandate—no one has standing to challenge it). The Court has held that Congress may delegate power to an administrative agency—e.g., to conduct the nation’s monetary policy—only when Congress specifies an intelligible principle to guide the agency’s discretion in exercising the delegated power.
One perfectly intelligible principle for the Fed would be: Go forth and do open-market mumbo jumbo to achieve maximum employment. Another perfectly intelligible principle would be: Go forth and do open-market mumbo jumbo to stabilize prices. But to demand both at once is scarcely intelligible, and hardly a principle. Basically we’re leaving it to the Fed to decide how to balance inflation and unemployment. And I guess that’s what the Fed will always say it’s doing—no matter what policy direction it takes.
Because of the Fed’s cherished “independence,” and because the Federal Open Market Committee (the Fed’s rate-setting arm) is stacked with regional Fed bankers, the Fed’s obscure, relativistic mandate is tantamount to untouchable regulatory capture. It’s not clear that auditing the Fed can change this underlying dynamic.
The Fed’s Dual Mandate
In her statement upon being nominated to be vice chair of the Federal Reserve Board of Governors, Janet Yellen mentioned the dual goals imposed by Congress on the Fed’s conduct of U.S. monetary policy. It is common to hear the Fed’s mandate described in terms of its “dual goals.” Here’s the actual statutory language:
The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.
I guess that language is just enough of a jumble that it doesn’t really matter that there are actually three goals: maximum employment, stable prices, and moderate long-term interest rates. Maybe the third gets lopped off because we think of the Fed’s control of interest rates more as a means than as an end. And because employment and inflation are the two recognized poles of monetary policy.
In more ways than one, though, it seems that the statutory language takes a back seat in directing Fed policy priorities. The word maximum in “maximum employment” is understood to be implicitly limited by the need to stave off inflation, though the need to escape high unemployment doesn’t seem to imply complementary limits to the pursuit of stable prices. Also, the statute’s more direct mandate has to do with long-run growth tied to increased production; the other two (or three) goals are almost afterthoughts.
I’m not especially knowledgeable about any of this, but I’d just note that this is a statutory provision which, however it was intended, seems tailor-made to supply obfuscatory justification of whatever direction Fed policy happens to take. There’s a little bit of everything in there, and the Fed Board and Federal Open Market Committee have immense discretion in their control of what is probably the government’s most consequential role in the economy. And that’s why these nominations matter so much.
Fed Nominations
A month and a half ago, the White House announced the names of three people the President would be nominating to fill the vacancies at the Federal Reserve Board of Governors. And finally today those same three people were actually nominated.
My first thought is: By the time the sun starts burning out, we will totally have this nut cracked! And my second thought is: I hope these three nominees are committed to raising the employment level.
Well, Janet Yellen, president of the San Francisco Fed and the nominee for vice chair of the Board of Governors, made some promising noises right out of the box today:
I am strongly committed to pursuing the dual goals that Congress has assigned us: maximum employment and price stability and, if confirmed, I will work to ensure that policy promotes job creation and keeps inflation in check.
Sounds good, maybe, I think. You know, in that deeply ambiguous monetary policy kind of way. Via Matt Yglesias.
Administration Moves on Fed Vacancies. Sort of.
The New York Times reports developments in Fed-vacancy land:
Moving quickly to put its mark on the Federal Reserve, the White House on Friday identified two economists and a lawyer as its candidates to fill three seats on the central bank’s board of governors.
Hey, good news. And not a moment too soon. Wait, what’s this—
“…but stopped short of declaring that those choices were final.”
Oh. Well, sure. Wouldn’t want to be hasty. So let’s recap: Obama takes office with two vacancies at the Fed’s Board of Governors. Roughly 415 days elapse. Then Friday, the White House is “moving quickly” to suggest some names for people it could maybe nominate at some point. Maybe soon. But, you know, not yet.
Okay! Well, there may be no score, but there’s certainly no lack of excitement here! The race to fill these Fed seats is proceeding at breakneck speeds.
(h/t Jonathan Bernstein)
Should Obama Make Recess Appointments to the Fed?
Brad DeLong thinks President Obama should fill the vacancies at the Federal Reserve by making recess appointments. Matt Yglesias is “not so sure about that”:
The Fed is one of the relatively few elements of the government that our national elite establishment takes seriously. When there was a need to reconfirm Ben Bernanke it got done, and quickly. I think that if Obama put some well-qualified names out there and made a point of emphasizing that he thinks quick action is needed, that he could get the job done.
I may be missing something here, but if the President thinks two new votes on the Fed Board might improve the odds that Fed policy would turn in a modestly more inflationary direction and help bring down unemployment, he should fill those seats as soon as his constitutional authority allows. I don’t really understand the argument against recess appointments here. He might ruffle some feathers. But so what? He could apologize and say it had to be done. The Senate is free to reject the appointees at the end of the session. And who really cares anyway?
The Fed chair is important and must be taken seriously in a way that the other seats on the board are not. (Chairs more important than seats. Hmmm….) The fact that multiple extended vacancies doesn’t make much difference in the functioning of the board—even if it makes a big difference in policy—seems to me evidence enough that nominations for these seats can be safely subjected to the usual treatment: maximal perversion of procedure for even the most minimal political gain.
More on Fed Vacancies
With soon-to-be three vacancies at the Fed and one already filled, President Obama could potentially fill a majority of seats (four of seven) on the Fed’s Board of Governors with his own appointees relatively early in his administration. (Five of seven if you count Bernanke. See previous post.) Members of the Fed Board serve staggered, 14-year terms, with one seat becoming available every two years. By design of the Federal Reserve Act, in a single term the President will make only two “scheduled” appointments to the Board, and a two-term President will have barely appointed a majority of Board members by the time he leaves office. These are some of the characteristic ways of making an “independent” agency independent—ways of limiting presidential control and influence over the board members. So it might seem that the opportunity the administration now has to revamp monetary policy through Fed appointments would be historic, possibly unprecedented. It might seem that way, but it isn’t.
Marriner S. Eccles Federal Reserve Board Building
In a review of appointments made to 12 independent regulatory commissions by presidents from Warren G. Harding through the George W. Bush, Neal Devins and David Lewis found that presidents have nearly always been able to appoint a majority (pdf) to each commission—ninety percent of the time. On average, they have appointed majorities to each commission within the first 26 months of their term. And they have achieved majorities for their party—adding to the ranks of commissioners appointed by previous presidents of the new president’s party—in just ten months.
The Devins and Lewis study did not include the Federal Reserve, but the authors note that only twice did presidents fail to achieve a majority on the Fed Board (Kennedy and Nixon).
The circumstances under which Obama took office have combined to accelerate vacancies. When a new president succeeds a president of the other party, as Obama has, there is typically a spike in vacancies, mostly due to resignations of partisans of the new president. Also vacancies typically increase in times of unified government, where one party controls both the White House and the Senate, as Democrats do now. The magnitude of both factors—party change in the White House and unified government—is proportional to the degree of polarization between the parties. And yep, we’ve got that, too.
So, if President Obama were to push through three Fed nominees this year—unlikely given election-year politics and the clogged drain that is the Senate confirmation process—he might be slightly ahead of the average presidential timeline, but the occasion is not at all unprecedented.
Still, unprecedented or not, it would be a shame to waste the opportunity. Those three seats at the Fed should be the first three items on the President’s jobs agenda.
Help Wanted at the Fed?
Marriner S. Eccles Federal Reserve Board Building
Throughout Barack Obama’s presidency there have been two vacant seats on the Federal Reserve Board of Governors—save for his first week in office, when there were three. One Obama appointee took his seat on January 28, 2009. This week the Fed’s vice chair announced he will be stepping down in June, opening up the possibility that within his first two years of office, Obama could make four appointments to the Fed—five, if you count Bernanke’s reappointment. (Bernanke was reappointed to the chairmanship, a four-year term. But his membership on the Board, a 14-year term, extends to 2020.) There are only seven seats on the Fed Board. Which means that Obama has a chance to reshape the country’s monetary policy by appointing a new majority of the Board (plus reappointing its chairman), potentially even before congressional mid-term elections. So far, the President has not nominated anyone for these vacancies.
Is this the historic, far-reaching opportunity that it seems to be? And if so, is the administration blowing it?
Well, not really. But it is probably way more important than anything else the administration can try to do to decrease unemployment. Because of its influence over interest rates and credit, the Fed has far greater and more direct sway over the level of employment than any other part of the government. The Fed is a big deal.
But the most significant power of the Fed—the ability to set interest rates through “open-market operations,” or the buying and selling of Treasury bonds—is wielded not by the Board of Governors per se, but by the Federal Open Market Committee (FOMC). The FOMC consists of the seven (7) members of the Board, plus five (5) private members appointed by regional Federal Reserve Banks on a rotation.1 That’s twelve (12) seats altogether.
So the four potential seats on the Fed Board that Obama could fill would not actually constitute a decisive majority on the FOMC. And according to this NYT story, the 5 FOMC representatives from the regional Fed banks tend to be even more hawkish on inflation than the Washington Fed Board members. So, because of their apparent aversion to any inflation at all, they are presumably unlikely to support the kind of credit-easing measures that could get businesses hiring again.
But hey, Mr. President, it wouldn’t hurt to try! It’s always possible that there are a couple of closet “unemployment hawks” on the FOMC. After all, the Federal Reserve Act mandates that the FOMC pursue a policy of “maximum employment” and price stability—not just the latter.
- This arrangement, whereby 5 of 12 seats on the FOMC are held by people not appointed by the President or by a department head, is pretty clearly unconstitutional. It clearly violates the Appointments Clause, but I’ll write about that another time. [↩]
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