Tag: federal reserve system

Diamond Down

Today Nobel Prize-winning economist Peter Diamond announced he is withdrawing his nomination to the board of governors of the Federal Reserve System. 

Professor Diamond, in the pages of New York Times, blames the opposition to his nomination on both partisan politics and what he sees as a misunderstanding of the relationship between unemployment and monetary policy.  Mr. Diamond, however, is the one with a fundamental misunderstanding.  We all know unemployment is an important issue and needs to be addressed.  The question is whether it can be addressed with loose monetary policy.  Mr. Diamond apparently believes it can.  There are many who believe it cannot.  If all our labor market problems could be solved with loose money, then we’d already be at full employment.  In case Mr. Diamond didn’t notice, we aren’t.  We also have gone down this path too many times before. The belief in a long-run trade-off between unemployment and inflation has the been source of considerable economic harm.

It is interesting that Mr. Diamond does not address the legal obstacles to his nomination.  The foremost is that there can only be one board member from the same Fed district at any one time.  As Mr. Diamond notes he has been at MIT “since 1966” and not living in Chicago, as the White House claims.  Whatever his academic qualifications, by law he is prohibited from serving on the Fed Board.  If congressional Democrats don’t like the law, they can try to change it, but we should not just ignore it.  Such only breeds a contempt for the law and a belief that the laws only apply to the masses and not the elite. 

So to answer Mr. Diamond’s compaint that ” Nobel isn’t enough,” I would answer: Exactly. A Nobel does not place one above the law.  Sorry, Professor, you’re going to have to live with the same rules that apply to the rest of us.

Federal Reserve Bank Pay Soars

The public is concerned that governments are providing excessively generous compensation to their workers. Attention has focused on the high salaries and benefits of federal civilian employees and the often lavish pensions paid to state and local workers.

The compensation policies of the Federal Reserve System also deserve scrutiny. The chart compares average wages of workers in the U.S. private sector and workers in the 12 Federal Reserve Banks. In recent years, the average wage in the Fed’s regional banks has soared, reaching $84,054 in 2009, or 67 percent greater than the private sector average wage of $50,462. Meanwhile, the average wage of the 2,100 workers in the Fed’s Board of Governors in Washington reached $116,030 in 2009. (Federal Reserve Bank data is from this annual report table. Private sector pay is from the BEA, as discussed here).

However, there is a major caveat to this Federal Reserve Bank data. Bank employment has fallen from a stable level before 2002 of about 23,000 to just 17,398 in 2009. One reason is that a major Fed activity—check processing—is rapidly declining due to technological changes. Thus, it is likely that many lost Fed jobs were at relatively lower salary levels.

Nonetheless, despite a 26 percent workforce reduction since 1995, overall Fed Bank compensation costs (wages and benefits) have grown just as fast as the overall economy. Fed compensation costs doubled between 1995 and 2009 as U.S. GDP doubled. The Fed’s total current operating expenses—including compensation, buildings, etc—also doubled during this period. (The Fed’s expenses are from this table in its annual reports. I excluded the new “interest on reserves” expense).

In 2009, total average wages and benefits of Fed Bank workers was $124,974, or more than double the $61,051 average compensation in the U.S. private sector. Fed workers have very generous benefits, including rare perks such as subsidized cafeteria meals.

Let’s look at top end of the Fed’s workforce. In 2009, the average salary of the Fed’s 12 regional presidents was $340,323. In addition, there were 1,183 “officers” in the Fed Bank system with an average salary of $198,960, which is up 94 percent from the average officer salary in 1995.

Also note that the number of these high-paid “officers” in the 12 Fed Banks increased 25 percent between 1995 and 2009 (950 to 1,183), even as the number of overall Fed employees fell 26 percent, as noted. The system is thus becoming very top-heavy.

Federal Reserve annual reports are available online back to 1995. But a 1996 report from the Government Accountability Office discussed the fairly rapid rise in Fed operating expenses during the 1988 to 1994 period, thus indicating that rising costs have been an issue for some time.

How does this affect the general public? Rising costs result in fewer central bank profits being transferred to the U.S. Treasury. That means higher federal deficits or taxes. The GAO explains:

“The Federal Reserve is a self-financing entity that deducts its expenses from its revenues and transfers the remaining amounts to the U.S. Treasury. Because an additional dollar of Federal Reserve cost is an additional dollar of lost federal revenue, the costs of operating the Federal Reserve System are borne by U.S. taxpayers just like the costs of any federal agency.”

As a monopoly immune from competition, the Fed will tend to have a bloated bureaucracy. That makes oversight by Congress very important so that technological efficiencies gained in Fed functions such as check-clearing are passed along to taxpayers, and not gobbled up, for example, by rising numbers of high-paid officers. As the Congress next year looks for ways to reduce the budget deficit, it should look for cost savings at the Fed.

Policymakers might consider whether the Fed really needs 12 regional bank organizations, each with huge fortress-like buildings in cities across the nation. They should ask why the number of high-paid “officers” has increased, even as the number of overall Fed workers has fallen. And they should ask whether Fed employees really need such generous benefit packages—including, for example, both a defined contribution and a defined benefit plan.

I’m not convinced that we need a monopoly central bank. But until policymakers explore alternatives such as free banking, they should try to reduce costs at the Fed as they scour the entire budget for savings.   

(Assistance was provided by intern Michael Nicolini).

Would Summers Be Any Worse than Bernanke?

As I have argued elsewhere, Bernanke’s record as both a Fed governor and Chair suggest we be better off with a new Fed Chair come January 2010, when Bernanke’s term as Chair expires. Outside of those who believe the bailouts have saved capitalism, two very reasonable arguments are put forth for keeping Bernanke at the helm:  1) in a time of crisis, the markets need certainty and dislike change; and 2) the alternatives, such as Larry Summers, would be worse.  Both these points have real merit, however I believe in both cases the pros of change outweigh the cons of staying the course with Bernanke.  I will save the “certainty” debate for another time, for now, let’s ask ourselves:  Would Summers really be any worse than Bernanke?

Before I make the case for Summers, I do want to make clear, President Obama, and the country, would best be served by a “Carter picks Volcker” type moment.  Go outside the Administration, go beyond the usual circle of easy-money, new Keynesians.  The Fed lacks creditability in two (at least two) important areas: bailouts and inflation.  And one doesn’t even need to go outside of the Federal Reserve System to find candidates.  Topping my list would be Jeff Lacker (Richmond Fed), Gary Stern (Minn Fed) and Charles Plosser (Philly Fed).  Any of these three know the workings of the Fed, have the respect of the Fed staff, and have taken strong positions on both “too big to fail” and easy money.  In the case of Gary Stern, it would seem especially appropriate, as his early warnings (see his 2004 book on bank bailouts) were largely ignored and dismissed.  If we want to reward and promote those who got it right, these guys are at the top of the list.

But let’s reasonably suppose that Obama wants someone close, someone he personally knows and will stick with tradition by picking a member of his own administration.  Without going into any detail, picking Romer would offer little substantial difference with keeping Bernanke.  The case for Summers is essentially that here is one instance where his enormous ego would be an asset.  One easily gets the sense that when Summers sits next to President Obama, Summers is thinking to himself just how lucky the President is to be sitting next to Larry Summers.  One can call Summers lots of things, starstruck is not one of them.  Given what we now need most in a Fed Chair is true independence, from especially the Administration but also from Congress, Summers is the only qualified economist close to the President who displays even the slightest streak of independent thinking.  Bernanke, in contrast, has endlessly pandered to the Administration and to Congressional Democrats.  Summers has been willing on occasion to actually defend the sanctity of contract (remember the debates over the AIG bonuses), a rarity on the Left, and more than Bernanke was willing to say.  

So forced to choose between Bernanke and Summers, the need for an independent Fed Chair willing to take on the Administration and Congress, when appropriate, makes Summers a far better choice.  That said, here’s to encouraging Obama go outside his comfort zone and pick someone who has the will to remove excess liquidity from the system before the next bubble gets going.

Is an Independent Fed Better?

Rep. Ron Paul now has a majority of the House of Representatives supporting his bill for an independent audit of the Federal Reserve System. He presented his case at a Cato Policy Forum recently, with vigorous responses from Bert Ely and Gilbert Schwartz.

Now more than 200 economists have signed a petition calling on Congress to “defend the independence of the Federal Reserve System as a foundation of U.S. economic stability.” The petition seems implicitly a rebuttal to Paul’s bill.

Allan Meltzer, a leading monetary scholar and frequent participant in Cato’s annual monetary conferences, declined to sign the petition and explained why: “I wrote them back and said, ‘the Fed has rarely been independent and it strikes me that being independent is very unlikely’” in the current environment.

Cato senior fellow Gerald O’Driscoll adds:

it is not the critics of the Fed who threaten its independence, but the Fed’s own actions.  Its intervention in the economy is unprecedented in size and scope. It is inevitable that those actions would lead to calls for further Congressional oversight and control. 

One of the lessons here is that once you create powerful government agencies, from tax-funded schools to central banks, there are no perfect libertarian rules for how they should be run. The way to protect freedom is to let people make their own decisions in civil society.  Schools have to decide what to teach, offending the values of some parents and taxpayers. The Fed can be independent and unaccountable and undemocratic, or it can be subject to the political whims of elected officials; neither is a very attractive prospect.

What Fed Independence?

More than 250 economists have signed an “Open Letter to Congress and the Executive Branch” calling upon them to “defend the independence of the Federal Reserve System as a foundation of U.S. economic stability.”

Allan Meltzer is not a signatory to the petition and he has explained why not.  The Fed has frequently not shown independence in the past, and there is no reason to expect it to do so reliably in the future.  Professor Meltzer has just completed a multi-volume history of the Fed and knows all-too-well of the Fed’s willingness to accommodate the policies of administrations from FDRs to Lyndon Johnson’s. 

I would add that the Fed’s behavior under Chairman Bernanke breaks new ground in aligning the central bank’s policy with Treasury’s.  Much of what the Fed has done, first under Bush/Paulson, and now under Obama/Geithner, involves credit allocation.  Since that ultimately involves the provision of public money for private purpose, it is pre-eminently fiscal policy.  Central bank independence is a fuzzy concept.  If it means anything, however, it is that monetary policy is conducted independently of Treasury’s fiscal policy.

In short, it is not the critics of the Fed who threaten its independence, but the Fed’s own actions.  Its intervention in the economy is unprecedented in size and scope. It is inevitable that those actions would lead to calls for further Congressional oversight and control.  The Fed is a creature of Congress and ultimately answerable to that body. 

The petition raises legitimate concerns about whether the Fed will be able to tighten monetary policy when the time comes, and exit from its interventions in credit markets.  But it is precisely the Fed’s own recent actions that raise those problems.  Critics of recent Fed policy actions have for some time complained that the Fed has no exit strategy.  Apparently the critics are now going to be blamed for the Fed’s inability to extricate itself from its interventions.

Cross-posted at ThinkMarkets