A FED FOR THE FUTURE
Today’s Wall Street Journal features my oped on a 21st Century Federal Reserve Board. The Fed map is so antiquated, it could’ve been mapped out on rawhide by Lewis & Clark! Here’s the text:
Janet Yellen and her Federal Reserve Board colleagues warn that they must nudge us out of the weird world of zero interest rates. But the entire decision-making apparatus needs to be nudged—or, better, shoved—into the 21st century. While some congressmen call for a Fed audit, the problem is not hanky-panky in oak-paneled boardrooms. The problem is that the Fed got gobsmacked by the Great Recession of 2008, the dot-com crash of 2000 and the credit crunch of 1990.
When the Fed’s forecasting fails, it imperils not just the economy but the very idea that free markets make people better off. Reform should aim to make the Fed better at its job so that markets can do theirs. Here are three important steps:
Redraw the map to represent modern commerce. Take a look at the Federal Reserve Board system, made up of 12 regional districts. Though it was set forth in 1913, it could have been mapped out on rawhide by Lewis and Clark. If you were allocating just 12 districts across 3,000 miles, would you place two of them in Missouri—Kansas City and in St. Louis? The Chicago Fed is less than 300 miles up the road, Detroit another less than 300, and Cleveland 170 miles further. The East Coast districts link closely connected Boston, New York, Philadelphia and Richmond, Va.—plus headquarters in Washington—as if purchased at an Amtrak ticket booth.
Meanwhile, look to the West and you’ll see that the Fed institutionalizes the joke about “flyover country.” The only Fed bank west of the Central Time zone is in San Francisco. I write this from San Diego, just miles from the Mexican border—one of the largest trade portals in the world—and an epicenter of the subprime mortgage meltdown. Yet when the San Francisco Fed president is somehow responsible for covering diverse places from oil-dependent Alaska to tech-savvy Seattle and Silicon Valley to Hollywood, and even for American Samoa and Guam. (Some Rocky Mountain states are under the jurisdiction of Dallas, Kansas City and Minneapolis.)
That made sense when Western commerce depended on a rickety Wells Fargo covered wagon pulling up into lonely towns with dry goods. But the Federal Reserve Board’s antiquated map leads to forecasting errors and poor policy. When the San Francisco Fed president speaks at Open Market Committee meetings to set interest rates, he gets equivalent time as Richmond, which covers a much smaller and less populous five-state area. Because regional Fed presidents vote on a rotating basis (unlike Washington-based governors), in 2017 San Francisco does not even get a vote.
Revise models to incorporate big data, new currencies and the gig economy. I have closely followed monetary policy since I corresponded with Milton Friedman as an undergraduate in the 1980s. But Friedman died in 2006, before bitcoins and blockchains entered the scene. The Federal Reserve must continue to monitor conventional metrics like bank balances, loan growth, jobless claims and commodity prices. Yet in recent years commodities have swung wildly, with oil hitting $115 barrel in June 2014 before collapsing to $60 in December.
The Fed must also learn to pay attention to crypto-currencies and to engines like PayPal that help drive the gig economy. I would argue that the gig economy has helped tame inflation by adding new supplies of land, labor and capital to the economy. Airbnb has effectively boosted by about 20% the number of hotel rooms in major cities. This is the new supply-side economics.
Pay attention to government policies that juice up demand or choke the supply of funds. Congress, Fannie Mae and Freddie Mac fueled the 2000s real estate bubble with their reckless drive to raise homeownership levels. By 2006 nearly 1 in 4 new mortgages was considered subprime. More recently, the Dodd-Frank Act has burdened community banks with regulations that squeeze off credit to small businesses. Within just a few years, then, policies juiced up and then dried up lending. The Fed must compensate for nonmarket, politically driven forces.
Despite the Fed’s flaws, it should not be put under the thumb of Congress or the White House. The Fed should act with independence, with prudence, with real-time data, and with an understanding that when it fails, it imperils livelihoods and the very credibility of democratic capitalism.