A Problem in the Fed's Structure

There are a number of problems with Federal Reserve decision making. But one that I think has been overlooked is the problem created by having the Fed serve two somewhat unrelated roles; monetary policy and financial stabilization. This seems to have lead to a problem in its institutional structure.

Broadly, financial stabilization encompasses the regulatory aspects of the Fed that seek to ensure a stable banking system. Monetary policy, on the other hand, involves macroeconomic stabilization through demand management. As Lars Svensson has pointed out, these are different roles, with different goals, and should be managed by different public officials.

In the Federal Reserve system the monetary policy role is conducted by the Federal Open Markets Committee (FOMC). This committee is made up of the Board of Governors of the Fed (appointed by the President and confirmed by the Senate) and a rotating group of regional presidents (selected by private banks in the region).

The regional presidents tend to be more hawkish in their approach to monetary policy, reflecting the views of  local banks within their regions. Appointing more dovish members to the Board of Governors should balance this out, however, in trying to negotiate the Fed's two roles, the President will often appoint regulatory and financial experts, with little experience in monetary policy. For example, currently the only two members of the Board with clear backgrounds in macroeconomics are Ben Bernanke and Janet Yellen. The rest seem to have been chosen because of their backgrounds in regulation and financial markets. (Note: Jeremy Stein gave a very good speech on Monetary Policy at Brookings recently, so maybe he knows more than his resume suggests) The regional presidents tend to generally be economists. This presumably tilts FOMC debate away from more dovish/expansionary policies, as fewer voices in the room are both economic experts and appointed by Washington.

Creating a separate Board for regulatory supervision or reserving additional seats for macro-economists could help remedy this problem.