A guest post by Benjamin Cole
It is an old trick question: What state has not one but two of the 12 regional banks of the United States Federal Reserve System?
Is it New York state, the nation’s financial, commercial and manufacturing powerhouse when the Fed was founded in 1913?
Or California, hundreds of miles in latitude with two huge metropolitan regions—San Francisco and Los Angeles—and a current population north of 38 million?
The Fed has regional banks in Kansas City, as in Mo., and another in St. Louis. Of recent note, there is also a Fed branch in Minneapolis. More on that later.
Do not misunderestimate these hinterland reserve banks, such as the KC Fed. Like the other 11 branches, the KC Fed houses its own staff of economists, who not only produce regional studies, but also pontificate on national monetary policy. And it is the KC Fed that hosts the Jackson Hole Economic Policy Symposium, which has become a rock star conclave by central banking standards. A gathering that can un-invite the unworthy. More on that later.
The KC Fed President also has a share in one of four seats of the Federal Open Market Committee, the 12-member body that meets behind closed doors every six weeks to divine U.S. monetary policy. Regional Fed bank presidents are selected by the regional bank’s board of directors.
So American prosperity depends, in part, on how the Kansas City chief votes, or the other regional Fed bank presidents.
Pursuant to a design first sketched by Rube Goldberg, the 11 non-New York Fed regional presidents, including the KC Fed chief, rotate in and out of four seats on the FOMC. The New York bank has a permanent seat on the committee, as do the seven members of the Board of Governors, who are appointed by the President subject to Senate approval.
You might think the job of regional Fed bank economic staffs is to tell their regional story to the big boys in D.C. They still do that, in part. But they have grander ambitions nowadays.
Since the 1980s, the staffs of the Fed regional banks have expanded and evolved into “schools,” usually called “freshwater” or “saltwater” schools. In general, conservative regions of the country have Fed banks that emit oblations to tight money, price stability and free markets (however abstruse the language or calculus), while the seashore regions sometimes expound upon growth and employment and international trade.
It looks like politics in economic drag, although deeply slanted to monetary conservatism. Judging from published papers, there is no one today at the Fed—not one—who will publicly aver, “Oh, 5 percent inflation would not be so bad, if the real economy expanded by 20 percent in real terms in four years, as it is did when Jimmy Carter was president, 1976 through 1979.”
If there is a Fed economist who assents to the above statement, I challenge that person to answer this post, with name attached, in the comments section.
Not that anyone in America seems to care or even know.
Aside from some Fed junkies and conspiracy theorists, the FOMC and the even the Federal Reserve are nearly invisible to the American public. Probably 90 percent of Americans could not pick Chairman Ben Bernanke out of police line-up of tattooed thugs, and but a few hundred people in the entire country could name more than a few members of the FOMC board or the 12 regional Fed banks. And most of those people work for the Fed.
In sum, the Fed national and regional bank economic staffs and presidents are safely ensconced, and removed from public scrutiny by virtue of obscurity. But with national ambitions—and that brings us to Minneapolis.
The Minneapolis Massacre
At all times, any independent public agency leans towards ossification, insularity, and complacency. Central banks are no exception.
There is no creative destructionism removing poorly performing central banks from the economy. Nor are voters a concern. In America, citizens cannot vote for a better central bank, except through the exceedingly indirect means of first electing Senators and the President. Voters have no say in the regional Fed bank presidents.
So the central bank is insulated. But, it can be argued, by devolving into schools the Fed regional bank staffs have chosen to further escape the rough-and-tumble of an impolite world of diverse ideas. Within the safe confines of their regional banks, Fed economic staffs are free to pursue their agendas away from noisome irritations, like people who disagree, or the public. Groupthink, confirmation bias, and intellectual inbreeding necessarily result from such arrangements.
And that brings us to the Minneapolis Fed, where recently Fed President Dr. Narayana Kocherlakota canned a few economists, including one who was not a Fed staffer but had a contract to provide advice on monetary policy. You know, there are not enough economists at the Fed (more on that later), so some extras had to be brought in to give advice on the macroeconomy. In Minneapolis.
While the Minneapolis Massacre has elements of an economists’ soap opera, the short story seems to be that the departed told Dr. K. that tight money was always the solution to everything. In abstract language no doubt, and behind a veil of objectivity strewn with calculus, but in the end, “tight money.”
Which reminds me of an old joke, about a maxim attributed to Irish rogues: “Alcohol: The cause of, yet the solution to, all of our problems.”
Evidently the Minneapolis Fed version was, “Tight money: The cause of, yet the solution to, all of our problems.”
Eventually, Dr. K. concluded that what he saw after 2008, year after year after year after year after year after year, was weak aggregate demand. Declining labor force participation rates. And dead inflation.
Dr K. began to have doubts that tight money was divine.
It must have been a shock to the fresh-H2O Minneapolisians, who want to play a part in national monetary policy, avers none other than blogger and academic Stephen Williamson, who had been a fan of the Minnesota bank staff.
“The Federal Reserve Bank of Minneapolis was a leader in bringing cutting edge macroeconomic research into contact with monetary policymaking,” writes Williamson. (Somehow, “cutting edge” excludes Market Monetarism; more on that later).
And Dr. K wanted to play in the big leagues, asserts Williamson. What Dr. K “said to us in Toronto in early October 2009 was something like: ‘These are interesting and trying times, and I think I have something to contribute.’ His primary interest seemed to be having an influence in Washington.”
Is that an outsized ambition, for a regional Fed bank president to play a role in national monetary policy? In practical terms, maybe not. More and more, the economics profession—especially those interested in monetary policy—is dominated by the Fed and its branches.
The Fed as Bully and Why Scott Sumner and George Selgin Are Wrong
Ace blogger and Bentley University academic Scott Sumner has lamented that the Fed won’t become more pro-growth, or adopt Market Monetarism, until the consensus within the economics profession adopts those sentiments. Sumner may not know what he is up against.
Sumner’s view is the Fed staff and board pretty much hew to profession-wide orthodoxy. Right now (in practice) orthodoxy is that anything even close to 2 percent inflation hazards price pandemonium, and the primary role of the Fed is to cap inflation, while real economic growth takes a back seat.
The always insightful and very pleasant George Selgin, University of Georgia scholar and free banking advocate, recently argued that central banks are mere pawns of the President.
But today it is the other way around—the consensus of the monetary side of the economics profession emanates from the increasingly rigid Fed, and Presidents cannot make the Fed budge anymore, as they did up through the 1970s.
The iron-willed Fed Chief Paul Volcker (1979-1987) and the Fed’s ecclesiastical reverence for microscopic inflation rates since Volcker has limited Presidential influence (if even Presidents chose to have any: see President Obama).
The Fed as 800-lb Gorilla
After decades of building up its staff, the Fed in D.C. employs 220 PhD economists, backed up by scores of researchers, support staff and computer gnomes. In fiscal 2009, the Fed said it allocated $433 million to analysis, research, data gathering, and studies on market structure, reports Ryan Grim, a D.C. on-staff correspondent for The Huffington Post.
The regional Fed banks add to the bulk, though no cumulative figures are available. The San Francisco Fed, for example, has 30 economists on staff. Some quick head counts at regional Fed bank websites suggest at least another 200 or so Fed econ doctorates work in the branch banks.
Dozens upon dozens of others work on contracts, like the one fired by Dr. K in Minneapolis.
And that ain’t all. The San Francisco Fed lists 31 “visiting scholars” on its website. Again, no system-wide numbers are available, but the numbers must be in the hundreds.
And in sheer numbers, the Fed dwarfs all rivals for the number of monetary thinkers; it may well employ more than the rest of the United States combined. Add to that influence all the visiting scholars and other hangers-on.
And that still ain’t all. Fed economists are influential at journals, especially the Journal of Monetary Economics, a near must-publish venue for monetary economists. But at recent headcount, more than half of the editorial board members were on the Fed payroll—and the rest have been in the past, reports Grim.
Economists as prestigious as James K. Galbraith, of the University of Texas, have complained the Fed essentially censors commentary in monetary journals.
Thus, I ask George Selgin and Scott Sumner (and anyone still reading), to ask yourselves: Where did Market Monetarism flourish? In academia? In the professional journals? At the Fed?
Of course not.
Market Monetarism, the most important movement in the field of economics today, flourished in the virtual Wild West—the Internet, in blogs such as the one you are reading and other superb venues. Way outside the Fed, where it should have been fomented and embraced.
Even Nobel Prizers whine about Fed snubbings. Paul Krugman said, “I’ve been blackballed from the Fed summer conference at Jackson Hole, (at) which I used to be a regular” for criticizing the Fed, in his case the former Fed Chairman Alan Greenspan.
So narrow has become the range of thinking at the Fed that Janet Yellen is now dubbed a “dove,” meaning she might like monetary stimulus. But Yellen has also rhapsodized about 1 percent inflation targets. If you are in the Fed, you must pay homage to institutional ideals.
Digression into Regional Papers
You can read some odd reports coming out of the Fed branches. I cited one in this space recently from the St. Louis Fed, to the effect that QE could be quadrupled with little effect on prices or output. Meaning also the Fed could pay off the U.S. national debt rather handily. Oh, that.
And from Kansas City Fed, we have a recent report entitled, Kinked Demand Curves, the Natural Rate Hypothesis, and Macroeconomic Stability.
From the abstract: “In the presence of staggered price setting, high trend inflation induces a large deviation of steady-state output from its natural rate and indeterminacy of equilibrium under the Taylor rule. This paper examines the implications of a “smoothed-off” kink in demand curves for the natural rate hypothesis and macroeconomic stability using a canonical model with staggered price setting, and sheds light on the relationship between the hypothesis and the Taylor principle. An empirically plausible calibration of the model shows that the kink in demand curves mitigates the influence of price dispersion on aggregate output, thereby ensuring that the violation of the natural rate hypothesis is minor and preventing fluctuations driven by self-fulfilling expectations under the Taylor rule.”
Do the guys in KC get outdoors much? Maybe this is “cutting-edge” research of the type favored by Williamson.
Is this really the way to make monetary policy?
Staffs at Fed HQ and 12 branches pumping out papers on the national monetary policy, usually serving to appease the ideology or social norms of the current branch President or the HQ in D.C.—and simultaneously squelching dissenting or new thought in the profession at large?
And policy set by a mysterious board, the FOMC, that meets behind closed doors every six weeks, and which includes regional Fed bank presidents with national aspirations?
But back to Dr. K, who is not the only regional Fed chieftain who wants play in the national stage. Other Fed presidents dance into the national limelight too, though often given to catastrophic flatulence in public, much like overloaded loose cannons rolling around the deck of a Fed ship uncertainly listing anyway.
Thus we have a Charles Plosser, the Philly Fed Chief, or a Dallas Fed President Richard Fisher, intoning about the glories of deflation, at the very moment when the Fed (at least ostensibly) is trying to convince markets it is serious about generating growth and at least enough inflation to get back to the low-bar but still undershot target rate of 2 percent.
Is the market supposed to expertly parse these various Fed official public proclamations, and know which are signals, and which are just gaseous propellant?
They can’t, I assure you.
The University of Oregon academic Tim Duy tries to decipher Fedspeak regularly at his blog Fed Watch. Duy often sounds like a 1960s-era Kremlinologist huddled over the shortwave, trying to interpret the latest minute changes in phraseology from Radio Tass.
Conclusion and Don’t Ask Me
I asked Marcus Nunes if I could guest post something about the Minneapolis Massacre, but the more I dug into the Fed and the 12 Fed banks, the more I found myself lost in impenetrable thickets, rabbit holes and Gertrude Stein’s downtown Oakland, as in, “There is no there there.”
I’m sorry I ever went down this path. I feel like a preacher returned from anarchic Sodom and Gomorrah, and tasked with explaining to the prim congregation what is wrong with the policies and governmental structure of those two cities.
So here is what I say: As an independent public agency, the Fed has become isolated, cloistered, insular, and has developed exalted internal norms and glorious mission statements.
Fed insularity is becoming magnified, as the central bank beefs up economic staffs nationwide and increasingly dominates the economics profession.
The result? The Fed and regional staffs are ever developing complicated models about inflation, a topic they are peevishly fixated upon, even as the US economy suffers from Japan-itis, that is to say low inflation and feeble growth, near or in zero-lower-bound land.
Does anyone in the Fed get it? There is a lack of aggregate demand, and there is surplus capacity and labor, and very low inflation. What are central banks for? Exactly this sort of situation. Gun the presses, dudes.
In a surprise, Minneapolis’ Mr. K. has perhaps come to the same conclusion. That is the good news.
The Bad News
But then, we also have Ester L. George, 30-year central bank employee and President of the KC Fed. She is a player too in national monetary policy, now in a voting seat on the FOMC. “My preferred course of action would have been to begin tapering asset purchases at last week’s meeting,” said George, speaking at the Colorado Economic Forum hosted by the Kansas City bank, in September.
The Denver Post reported that George has been the most vocal insider calling for the central bank, in Washington, D.C., to reduce its monthly purchases of $85 billion in bonds, which she argues risks creating inflation and “imbalances” in the economy.
How does one suppose Ms. George comes to her conclusions?
By taking cues from President Obama, per George Selgin? Or from a consensus of non-Fed economists, per Scott Sumner?