In this morning’s Wall Street Journal, in an op-ed entitled “Misreading the Fed on a Rate Increase“, Benn Steil argues that, for the purpose of predicting changes in the stance of monetary policy, Fed-watchers may be watching the wrong body. Instead of paying attention to the views of members of the Federal Open Market Committee (FOMC), he says, investors and others should focus on the Fed’s Board of Governors, the subset of the Committee that resides permanently in Washington.
It’s well known that, within the FOMC, the influence of individual participants on policy decisions varies. The seven members of the Board (when all seats are filled) each have a permanent vote on the FOMC, whereas only five Reserve Bank presidents vote at each meeting. Moreover, in practice, greater sway over policy is held by the chair and those close to her, as well as by those Committee participants (even those without a vote at a particular meeting) who are most persuasive in the internal debates.
Mr. Steil’s argument, however, is not about the influence of individual participants in FOMC decisions. Rather, he makes a more technical point. He notes that, because of the Fed’s large balance sheet, traditional methods of controlling the federal funds rate (the Fed’s policy rate) will not work today. Instead, to raise the federal funds rate when the time comes, the Fed will have to rely on novel tools, including changes in the rate of interest it chooses to pay on reserves held at the Fed by commercial banks. The 2008 law that gave the Fed the power to pay interest on bank reserves vested the authority to set that rate in the Board, not the FOMC. Mr. Steil concludes that the Board rather than the FOMC actually controls monetary policy.
Mr. Steil is correct that the interest rate paid on reserves will be one important tool for influencing short-term interest rates—a point that Fed policymakers have been quite open about—and that, by law, the Board sets that rate. He might note that other important tools for influencing short-term interest rates, such as the so-called reverse repo facility, are under the control of the FOMC. More fundamentally, though, in concluding that the Board will consequently control monetary policy, he misunderstands how the Fed actually works. Whatever the technicalities, Fed policymakers know that the expectation of the Congress and the public is that monetary policy will be made by the FOMC, not the Board—an expectation reinforced by decades of Fed practice. During my time as chair (of both the Board and the FOMC), we were explicit both internally and externally about the primacy of the FOMC in monetary policy, an understanding that was fully supported by members of the Board as well as by other FOMC participants. My successor, Janet Yellen, is a strong believer in developing broad policy consensus. I am sure that she will continue to involve fully the whole FOMC in monetary policymaking, and that she and the Board will do whatever is necessary to implement the decisions of the larger body.
There is historical precedent for the Board having technical authorities that in practice were subordinated to FOMC decisions. The Board has long had the authority to set the discount rate, the rate at which regional Reserve Banks lend to banks in their districts. Under traditional operating procedures, the discount rate helped anchor the federal funds rate, and it was kept at a level just below the target for the funds rate set by the FOMC. The Board did not use its authority over the discount rate to try to exert an independent influence on monetary policy; rather, when the FOMC changed its fund rate target, the Board routinely and automatically adjusted the discount rate in tandem with the FOMC’s action.
If you want to understand and predict Fed decisions on interest rates, you will be well advised to follow the debates among the FOMC and its leadership. The views of Board members are relevant, of course, but because Board members are also voters on the FOMC, not because there is any risk that the Board will try to block implementation of an FOMC decision.
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