Changing Governance Practices Seem to Have Reduced the Diversity of Views at the Federal Reserve, �which may have contributed to recent poor performance

Jeffrey M. Lacker

Shadow Open Market Committee

New York, NY

April 5, 2024

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FOMC sets (“secret”)

2% inflation target

Many factors contributed to Fed’s poor performance

For example:

• Effects of the revised framework document adopted in August 2020
• Strong forward guidance provided in September 2020 statement
• Overestimation of labor market slack in 2021
• QE protocol: Commitment not to raise rates until purchases end

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An additional factor worth considering:

• Could Fed decision making have benefitted by more robust engagement with diverse perspectives?

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Declining diversity: causal conjectures

Observations:

• Frequency of dissents has been declining
• Less divergence in public statements by FOMC participants

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Two conjectured causes:

• Board is now more involved in searches for Reserve Bank presidents
• Less diversity of views, lower propensity to dissent
• Norms regarding public communication have shifted
• Less public expression of alternative views

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Selecting Reserve Bank presidents

• Presidents appointed by the nonbanker directors of the Reserve Bank, “with the approval of the Board of Governors” [FRA]
• Name of final candidate sent to Board for informal clearance
• If no objection, directors vote & formally submit name to Board
• If Board objects, they “suggest” reconsideration
• Directors can either reaffirm their choice or nominate someone else
• Stand-offs not unknown
• Chair of the Board’s “Bank Affairs Committee” is the point main of contact throughout the process

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Selection process has changed

Old process: run by (nonbank) RB directors, Board role limited until final approval

New process: frequent consultation, Board co-management of the search process

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• Conjecture: Board has used its more active role in presidential searches to steer Reserve Bank boards toward candidates with a greater affinity for the Board’s policy views and a disinclination to publicly diverge from those views.
• That may have been the Board’s motivation for more active involvement in presidential searches.

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A rough indicator

• In 2009, over half of the presidents had records of multiple academic journal publications in monetary economics and macroeconomics
• Arguably better prepared to come to well-grounded divergent assessments
• Arguably greater willingness to question majority’s view
• Arguably greater confidence expressing independent views publicly
• Note: not a prerequisite, just a correlate
• All but 2 had left by late 2021 (both of those have since retired)
• Of 13 new presidents since 2010, just 1 fits that description (Williams)

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Norms for public communication

• Greenspan regime: Chair was sole conduit for monetary policy views
• Give and take during FOMC meetings somewhat limited
• Participants rarely said anything substantive about policy prospects
• Bernanke promoted transparency and open communication
• More latitude for participants to express personal views, both inside and outside FOMC meetings
• Aided public understanding, but sometimes politically inconvenient for Board
• FOMC now behaves more like a corporate board
• Dissent kept internal, common message externally (“house view”)
• Greater Chair control over messaging, less ammunition for external critics

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Chair Powell on public communication of diverse FOMC participant views

• “In my view, the public expression of our diverse views helps sustain public support for the Federal Reserve as a public institution.
• “Those members of the public who disagree with our policy should know that their concerns are given voice in our deliberations.
• “But there is a tradeoff here that needs to be managed: On the one hand, the effectiveness of policy is thought to depend on the public's understanding of the Committee's consensus.
• “On the other hand, the expression of diverse views may sometimes make it difficult for the public to see that consensus.”

- Powell, November 30, 2016

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Does he mean “Consensus” or “Chair’s view”?

Merriam-Webster definition of consensus:

1a. general agreement: unanimity

1b. the judgment arrived at by most of those concerned

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If there are diverse views, how much of a consensus is there?

Why not let the public see how much of a consensus there is, or is not?

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Trade-offs in communication regimes

• General presumption in deliberative bodies:
• The quality of decision-making is stronger when diverse perspectives are voiced and given serious consideration
• Motivated federated structure of Federal Reserve system at the founding
• External articulation of alternative views:
• Improves public understanding & enhances incentive to take them seriously internally
• Compare FOMC with SEC, FDIC, SCOTUS, where dissenting views fully shared
• In its upcoming strategic review, the Fed (especially the Chair) should reconsider its stance regarding diversity of views

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