Democracy in America

American politics

Fed policy

Business and tight money, a mysterious love story

Sep 10th 2010, 13:48 by M.S.

I'M SYMPATHETIC to Matthew Yglesias's argument that, with unemployment at 9.6% and inflation at 1.2% over the last 12 months, money is too tight in America right now. It's true that Narayana Kocherlakota, the president of the Minneapolis Federal Reserve, has been arguing in recent months that there's little the Fed can do to fight unemployment, because it's a structural problem. That's an argument with strong political overtones, and the composition of the members the Federal Reserve boards is surely an important determining factor in how they see their mission and where they line up on questions like these. But I think there's a missing piece in this part of Mr Yglesias's argument:

[I]t’s really time to revisit the absurd governance structure of these entities. The regional Fed presidents exercise important public policy authority, but they’re primarily selected by local for-profit business interests rather than by public officials. It would be as [if] half the Supreme Court justices were selected by corporate law firms dispersed around the country. As long as the Fed seemed to be performing well, I suppose most people took an “if it ain’t broke don’t fix it” line. But the country is mired in tight money, and the regional feds seem to be behind it.

The question here is, why would it be the case that having local for-profit businesses select the members of a central bank authority would bias them against monetary intervention and demand creation, and towards tight money? Why would local for-profit businesses be less likely to see the advantages of stimulative monetary policy than some other interest group one might select? After all, if demand goes up, business profits go up; assuming looser monetary policy is a good idea right now, one would think local businesses as likely as anyone else to support it.

For example, take a look at the 9-member Board of Directors of the Minneapolis Federal Reserve, which selected Mr Kocherlakota. As with every regional Fed, the Minneapolis Fed's directors come in three flavours: top, bottom, and strange. Sorry; I mean Classes A, B, and C. The three Class A directors are local bankers, elected by local banks. And, as Mr Yglesias might argue, one could certainly imagine that local banks might be hypersensitive to any inflationary risk in expansionary monetary policy, and insufficiently interested in taking steps to get more Americans employed.

But then you've got the Class B and C directors, who cannot be officers or employees of any bank. They're supposed to be local businessmen, labour reps, or other prominent citizens. The Class B directors are elected by local member commercial banks, while Class C directors are appointed by the Fed's Board of Governors in Washington.

In Minneapolis, the Class B directors are Howard Dahl, Todd Johnson, and William Shorma. Mr Dahl is the CEO of Amity Technology, which makes farm machinery. Mr Johnson is the CEO of Reuben Johnson & Son, a construction company. Mr Shorma is the CEO of Shur-Co, "Your Tarping Solutions Company!" (Warning: do not visit the Shur-Co website unless you are prepared to experience an immediate desire to purchase some tarps.) You would think that any of these guys stands to benefit from an acceleration of demand fueled by looser money in a below-capacity economy.

Then you've got Minneapolis's Class C directors. Mary Brainerd is the CEO of HealthPartners, a not-for-profit HMO. Randall Hogan is CEO of Pentair, which makes pumps, filters, and pool equipment. And John Marvin is CEO of Marvin Windows & Doors, home of the Ultimate Double Hung window. Again, each of these folks would be well served by more demand. So what's the connection between the group interests of the directors and the policy preferences of the president they pick?

You could argue that the fact that local banks pick the Class B directors, while the Fed's governors pick the Class C directors, ensures that ultimately they're representing the interests of banks, and not so much those of business—let alone those of consumers, labour, civic associations, or every other way to group citizens in order to express their many interests. That's actually a violation of the spirit of the Fed's charter. Class B and Class C directors are supposed to "encompass the broad economic interests of the District, including industry, agriculture, services, labor, consumers, and the nonprofit sector." The fact that every single member of the Minneapolis Fed is either a banker or a business executive makes a travesty of that principle. The interests of consumers and workers ought to be represented in choosing regional Fed presidents.

But I still think you need to have a theory as to why a group of prominent local businesspeople would be more likely to pick a regional Fed president who wants tight monetary policy than one who wants loose monetary policy. And at that point I think you start getting into the fuzzy terrain of people's economic ideologies, which aren't always entirely coherent. Or rather, people's spoken economic beliefs often conflict with their actual economic behaviour, or with their ultimate interests. For example, the Fed itself, as noted on its "Kids!" page, has the sometimes incoherent twin mission of restraining inflation and promoting full employment. But while it has a neat little section explaining what a bad thing inflation is, it doesn't have a section explaining what a bad thing unemployment is, or what the Fed can do about it. Which tells you something about its actual priorities.

(Photo credit: AFP)

Readers' comments

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Tariq Scherer

I'm making a wise-crack here, that Shur-Co company, the one that sells Tarps: those are tarpaulins, right? Not TARPS, Toxic Asset Recovery PlanS? If the latter, that would be funny...

But bad sense of humour aside, the Fed system does represent a surprising level of federalism and broad-party interests. I was completely ignorant of the depth and level of community involvement that the Fed brought about at the state level and think that such initiatives are highly commendable.

Out of curiosity, does the BofE, ECB, RBA, BoJ have any such level of multi-disciplinary representation? I know that the Australian RBA has a select group of private sector invitees to its board of governors (who are high-profile business leaders) but certainly not an ongoing level of private engagement through-out its divisional ranks.

As to who would be best equipped to engage with economic matters: economic view points aside, the Fed is highly reliant on quantitative analysis and I could imagine this favouring private sector for profit candidates, especially those with a financial sector background. That is not to say that there is not a wide range of other quantitatively attuned sections of the population that could gain from increased visibility (engineers, accountants, surveyors, etc) but to then expect community leaders, social representatives or legal eagles to take views on economic matters would be worrying. The skills of the three previous groups are valuable and indeed extremely scarce within society but I think they would be put to better use in other branches of the public sector rather than that of monetary policy planning.

TS
http://scherer.dyndns-web.com/

A Young

I'm rather perplexed by the conclusions of this article.

You concede:
A) "one could certainly imagine that local banks might be hypersensitive to any inflationary risk in expansionary monetary policy"

Also, you recognize that:
B) banks elect six out of nine of the regional Fed directors

Yet you fail to find "a theory as to why a group of prominent local businesspeople would be more likely to pick a regional Fed president who wants tight monetary policy than one who wants loose monetary policy".

The crux of your conclusion seems to turn on the fact that Class B directors have interests that diverge from the banks'. That's not particularly convincing. Banks elect them. Banks are savvy institutions. Given those two facts, it's not hard to imagine that the banks would select individuals whose interests are aligned with their own - divergent business interests or "spirit of the Fed's charter" not withstanding. If Chemco elected two thirds of your city council, would you not question a city initiative to relax drinking water standards, simply because half of the Chemco appointed council members are also citizens with an interest in clean water?

I think the burden of proof lies with those wishing to argue that Class B directors do not serve the banks.

Pacer

bambps,

Maybe fear is a good thing; I for one see lots that we should be fearful enough to be taking more seriously than we are.

We ought to fear the trade deficit (the giant sucking sound of wealth leaving our country) and get serious about wasting money on foreign-made discretionary purchases versus saving or paying down the debts we voluntarily accepted.

We ought to fear quickly rising energy prices, and be making every effort to improve personal efficiency.

Fear of global warming ought to make us more inquisitive about carbon pricing, and finding ways that it can be done at greater penalty to foreign manufacturers than our own domestic ones.

Fear of government corruption and how until we root it out and banish all transgressors we're just throwing our taxes away on activities that often come back to harm us.

But maybe fear isn't enough. Maybe pain is what it will take. In that case we ought not fear some employment pain and even unrest; these are far lesser evils than the collapse of the dollar. A broken currency would leave us with even fewer means to rectify our country's many fatal weaknesses.

bampbs

cognate, you are not allowing for the market failure that occurs when confidence goes to extremes. Right now, people are more pessimistic, less willing to take on risk, than is rational. If government doesn't spend extra money that goes to the private sector, sound businesses will fail. That is not "creative destruction"; it's a loss of capital that would have contributed to future growth.

cognate

Contrary to Keynesian tenets, inflation does not reduce unemployment --not in a healthy and sustainable way. When the FED hands over newly printed money to politically favored interests, the end result is a transfer of wealth, via inflation, from everyone to those special interests. If, in an attempt to reduce unemployment, the newly printed money is used by the government to hire workers, the stuff and services they produce are inherently suboptimal --otherwise their economic activities would have happened on their own.

Despite the temporary, immediate, superficial and shortsighted apparent benefit of hiring workers with printed money, it is at bottom just an ineffecient transfer of wealth scheme from one part of the economy to another. The Keynesian multiplier is a myth.

sweatshop fan

You mentioned the bank's natural aversion to inflation, but apparently didn't take into account the six CEO's shared fear of inflation.

Assuming all six of these CEO's are late in their career, inflation is a direct threat to their wealth, a threat that increases with the more cash type assets they have. If a CEO has $25 million total assets, $10million of which is cash/bonds/tbills etc, then 8% inflation will essentially cost him $800,000, and that's only for the first year.

Deflation, on the other hand works very much in his favor. He can spend $3 million on a yacht and the 7 million left over keeps increasing its buying power without him having to do any work to make more money.

Perhaps Mr Yglesias just assumed this was self-evident. Apparently for Economist writers it is not.

Doug Pascover

No, I agree Jayxray, but I think in the current discussion, the FED is expected to take employment as their first duty and I also think this entirely misunderstands what their role ought to be. Obviously, they should not and are not trying to stop wage inflation from too many employed people.

But I think they're actually at a point of existential crisis which explains some of the conservatism people are deploring. Last week, Buttonwood had a post up that there is evidence the monetary multiplier has collapsed. If people stop believing they can stimulate economy through monetary policy and with rates at the zero bound, their only tools for stimulus may be regulatory relief for banks, in particular reducing reserve requirements. Find me someone who thinks the FED should be doing more to create jobs and also that banks need more freedom, particularly lower reserve requirements.

I think that's the nightmare the FED ought to be very cautious to avoid and I think we should let them. I doubt there are enough jobs yet to be created with monetary policy to be worth that level of risk.

jayxray

Hi Doug,

I know that I've read about when 'maximum employment' became a stated goal of the Fed, but I can't remember the details.

I do know the history behind it though: apparently the Fed came to the conclusion that low inflation outweighed full employment so they decided that a target rate ~5% is acceptable. Now the Fed has done nothing but screw up since the '70s, so I'm not sure their reasoning is solid.

Regardless, it's an odd situation where a stated goal of the government is to ensure that millions of Americans should remain unemployed in the name of fighting inflation.

bampbs

We'd be much better off if everyone connected with monetary policy was chosen at random from the phone book. One week terms, too. I want to increase my chance of being Fed Chairman.

Doug Pascover

Thanks, Jayxray. What I'm really curious about is whether "full employment" is supposed to have equal priority for the FED. I think it would be ridiculous if it were, but always suspected that was added on later, probably after a suspiciously dour FED broke the economy. I googled around and still don't have a 100% answer, but it looks like the Hawkins-Humphrey Act of 1978 might have added that in. What I did find that is interesting is that it is "maximum employment" rather than full employment. We might be at or near maximum employment now, given the minimum wage laws and reduced worker mobility.

martin horn

OneAegis raises a good point.
Perhaps Shur-Co's site have Admiral Ackbar endorse their products by announcing, "It's a TARP!"

He's got popular appeal. The Ole Miss Rebels, when trying to choose a mascot, settled on Admiral Ackbar (the student body took a vote.) Of course, George Lucas torpedoed idea, but I'm sure for enough cash, Lucas would be willing to sacrifice some of his intellectual property.

The story is well-told by this ESPN commercial:
http://www.youtube.com/watch?v=Jx0pTIDb-r0&feature=player_embedded

SGT21

the idea that bankers' interests ultimately control who is selected to regional FED positions is a bit dubious...although i appreciate the mancur olson implications of the argument...

...perhaps the fact that mr. kocherlakota is a nice winnipegian (with an awesome german/native american name) means more to minnesotans...

...in other news i just bought a tarp...

whaleyboy

I am generally unsympathetic to anything that Matthew Yglesias writes and have to fight off a cringe when I see a quote from him.

Then I remind myself that I read DIA to avoid having to skim writers like Yglesias. The blogger needs to get out more ;)

In the spirit of balance I offer this blog/website: http://www.ydiot.net/ - a nice debunking of Yglesias' writing with a little snark thrown in. I have nothing to do with the site except consuming the content.

k.a.gardner

Is 'top, bottom and strange' a colorful metaphor for a quark? Which is a tasty metaphor for a regional Federal Reserve Bank? Or is that link misplaced?

Also, can you provide us with fuzzy charts of current non-farm payroll employment from St. Louis Federal Reserve Bank later this afternoon?

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