“U.S. President Donald Trump’s radical shift in economic approach has already begun to change norms, behaviors, and institutions globally. Like a major earthquake, it has given rise to new features in the landscape and rendered many existing economic structures unusable,” or so says Adam Posen at the Peterson Institute. After last week, it looks as if the Federal Reserve as it came to be known over recent decades is also on the scrap heap. It may not be “unusable,” but the uses to which it will be put are to serve Mr. Trump’s political interests, not necessarily those also of the long-term economy’s resilience, equality, or stability. The Fed deserves this due to its geriatric monetary-policy model and persistent contributions to economic inequality. I’m not so sure about the rest of us.
The transformation already under way is not just the result of the President’s unprecedented effort to dismiss a member of the Federal Reserve Board and, if the courts rule in his favor, anyone else he doesn’t like. Another profound change could come next March, when the Board must ratify the appointments of Federal Reserve Bank presidents. With a majority of members of the Board on his side, Mr. Trump could block reappointment of all twelve Reserve Bank presidents in March of next year.
The Federal Reserve Act places a rolling list of five Reserve Bank presidents on the FOMC in an effort to balance what congress feared in 1913 would be undue Wall Street influence on monetary policy if the only votes came from the Board and the Federal Reserve Bank of New York. As with the Board, the Reserve Bank system is geriatric and in long need of redesign. But, also like the Board, the President’s scorched-earth approach to reform is likely to be considerably more destructive than an improvement. The Fed isn’t always right – far from it – but it does try to be right. Political leaders are almost always less interested in right than might.
How best to redesign the Federal Reserve Banks? The President’s pending nominee to the FRB, Stephen Miran, has proposed one approach in concert with sweeping changes across the System as a whole. Among other things, he would change the manner in which Reserve Bank presidents are currently appointed, replacing the current process strictly within each Bank under the Board of Governors’ eye with a more political option. Under it, state governors across a Reserve Bank’s district would pick each president. This, Mr. Miran believes, would make the Reserve Banks accountable to the people they serve without being unduly partisan because governors across a Reserve Bank’s districts are likely to be of varying parties and persuasions.
Sen. Warren, who otherwise has little in common with Mr. Miran, shares his disdain for the current way Reserve Bank heads are appointed. Her most recent views do not include a how-to, perhaps because the longstanding approach preferred by Democrats – presidential appointment along with Senate confirmation – has lost its appeal now that Mr. Trump is in the Oval Office.
The practical challenges to Mr. Miran’s ideas and the political obstacles to Sen. Warren’s might argue for another century’s worth of Reserve Banks as they are, but I doubt it. Even if Mr. Trump does not reconstruct the Reserve Banks via brute force, we are virtually sure to get a new model for how to design the U.S. central bank from the Treasury Department well before a new Fed chair takes charge next June (or, perhaps, sooner if the courts side with the White House on Ms. Cook’s dismissal).
Although the March tussle over Reserve Bank presidents is imminent, there is much else about the Federal Reserve Banks that warrants rapid reform. Ideally and in very brief, Congress should redesign the Reserve Banks so that their locations reflect America as it is now, not as it was in 1913. It makes no sense to have Reserve Banks in cities such as Boston, Philadelphia, and Richmond and to have both a Kansas City and St. Louis Fed, but only one Reserve Bank in San Francisco to address all the U.S. west of the Mississippi.
If member banks continue to own the Reserve Banks, then Reserve Banks should stick to tasks suitable for corporate hybrids such as handling payments and studying topics of particular concern within each Reserve Bank district. Further, the Fed can and should be forced to price its payment services in a truly competitive way, not via the “private-sector adjustment factor” the Fed has consistently disregarded as it grew to dominate payments over the past forty years. If districts are modernized to reflect geographic reality, then Reserve Bank research might even matter when it comes to understanding regional realities and provide useful alternative views. But, supervision should be sent to the FRB in Washington, with each Bank hosting district supervisory staff that report to DC just as done by the OCC, FDIC, and every other federal financial regulator. Owners should not be choosers.
Even with supervision moved out of the hands of private owners, the Reserve Bank presidents need to be federal officials if they are to retain their seat on the FOMC and thus be accountable for their monetary-policy judgements along with the way they run their Banks. To prevent the complete wipe-out Sen. Warren fears and ensure long-term stability, Reserve Bank presidencies should commence on staggered five-year terms, not the current all-or-nothing requirement that gives Mr. Trump the opportunity to call the monetary-policy shots the way he likes them.
As Mr. Posen rightly concludes, the old financial construct has been incinerated. This is a far more traumatic way to redesign a central bank than anyone should want, but it’s what we’ve got. The best way to move forward is not to await a return of the good old days, especially since they weren’t all that good, as Democrats readily acknowledged until Mr. Trump rolled back into town. It’s more than timely to put hard thought into what a new Fed should be, redrawing the Reserve Banks and much, much else besides.