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Commentary on ‘Presidents, politics, and the Federal Reserve Board governors: Is there a new PhD standard?’
Good morning and welcome to today’s AEI policy event, “Presidents, Politics and Federal Reserve Board Governors: Is there a new PhD standard?” My name is Paul Kupiec. I am an AEI resident scholar and the organizer of today’s event.
President Trump has had a particularly difficult time finding and confirming Federal Reserve Board governors. This past spring, two potential nominees were vigorously attacked in the press and both were forced to withdraw their names from consideration. A common line of attack was that these individuals lacked the proper “qualifications” for the job.
What qualifications are needed to be a Federal Reserve governor? The Federal Reserve Act of 1913 created the Federal Reserve Board. In 1913, Congress decreed that the Board be comprised of:
seven members, including the Secretary of the Treasury and the Comptroller of the Currency, who shall be members ex-officio, and five members appointed by the President of the United States, by and with the advice and consent of the Senate. In selecting the five appointive members of the Federal Reserve Board, not more than one of whom shall be selected from any one Federal reserve district, the President shall have due regard to a fair representation of the different commercial, industrial and geographical divisions of the country. … Of the five members thus appointed by the President at least two shall be persons experienced in banking or finance.
The Banking Act of 1935 removed the Secretary of the Treasury and the Comptroller from the Board, changed the title of the Board’s executive governor to chairman, extended the term of governor to 14 years, and raised governor pay from $12K to $15K per year.
There are few legal constraints regarding the qualifications for a Federal Reserve Board governor. An economics PhD is neither necessary nor sufficient. The current Federal Reserve Chairman is a lawyer as is the incoming Chair of the European Central Bank. President Trump’s two prior nominees for Fed governor—both well-respected PhD economists, including a lifetime Fed staff economist—failed to receive Senate confirmation. The current Federal Reserve Board has only two PhD economists—a rare situation in modern Federal Reserve history.
Today, media discussions of nominees primarily focus on the monetary policy implications of a potential appointee. In practice, the Federal Reserve Board shares authority over monetary policy with voting reserve bank presidents on the FOMC. However, Federal Reserve Board governors have exclusive control over the Fed’s many regulatory functions.
Practically speaking, the qualifications for Federal Reserve Board governor (including chairman) are entirely political. To be nominated, a person must be politically connected and earn the trust of the president. That nominee must also be sufficiently adept at politics to earn Senate confirmation. The over-riding importance of political skill may help explain the current deficit of economists on the current Federal Reserve Board. PhD economists who are also virtuoso politicians are a rare breed.
Until recently, a PhD in economics did appear to be de rigueur for a Federal Reserve governor. Since 1980, only one Vice-Chairman was a non-economist (Roger Ferguson), and only two chairman lacked economic PhD’s (Paul Volcker and Jay Powell)—and certainly Paul Volcker must count as a card-carrying economist. Since 1980, by my rough count, there have been 43 individuals who have served as Federal Reserve Board Governors (including as chairman). Only 11 were not PhD economists or the equivalent thereof (Paul Volcker and Charles Partee— a lifelong Fed economist and research director did not have PhDs).
Should an economics pedigree be an important consideration in the governor confirmation process? The Federal Reserve Act of 1913 stipulates that at least two governors have experience in banking or finance but at that time, the Federal Reserve had no formal macroeconomic stabilization and growth mandate as it does today. Should the Federal Reserve Act be amended to require that at least some governors have expertise in macroeconomics and monetary theory?
Before answering, it is useful to consider whether today’s PhD training in economics actually imparts skills needed to successfully manage the Federal Reserve. Do PhD macroeconomists really have the secrets of the temple needed to steer the economy on a low-inflation, high-employment trajectory? Back in 1977, the AEI hosted a policy event entitled, “Professors, Politicians and Public Policy.” Let’s take a moment to revisit the views of this distinguished panel from 42 years ago.
Just last week, Gerard Baker of the Wall Street Journal offered a different explanation for the Board’s current deficit of PhD economists. To paraphrase Mr. Baker,
The cult of the (PhD economist) central banker grew out of a search for a solution to the great inflation of the 1960s and ’70s… politicians ceded power to the technocrats as the only way to stop themselves from printing money. But the great inflation is long gone… And it is no surprise that our political classes have had enough of genuflecting at the altar of central banking.
Depending on your politics, there may be other downsides to appointing a Fed Board packed with PhD economists. Many abstract theoretical models in economics formulate optimal policy solutions by modeling the government as a benevolent dictator that can control the economy. Some economists seem to take these theories literally as many PhDs favor policies that have a larger more intrusive role for government and regulation. The issue is not new as a clip from our 1977 AEI panel will show:
To be fair, and as Professor Bork mentioned, on average lawyers are probably just as likely as PhD economists to favor a larger more intrusive role for government and regulation. But again, it depends on the individual. Governors like Dan Tarullo fit the stereotype, but there are governors like Randal Quarles who are exceptions.
The Fed certainly needs PhD economists on staff, but is the country better served when the Board of Governors is dominated by PhD economists? PhDs may be well-trained in economic theory, but does the current state of theory provide the best framework for formulating real-world monetary policy? When it comes to monetary theory, the words of the great American philosopher Yogi Berra are apropos,
“In theory there is no difference between theory and practice. In practice there is.”
An analogy may help clarify the issue. Say you are traveling from Baltimore MD to Lisbon Portugal by airplane. Abstract models and technology are essential for charting an optimal course. The shortest route, a so-called great-circle route, is calculated using spherical geometry. Corrections are required to account for the speed and direction of the jet stream, but in most cases, this navigational model plots the fastest most efficient path from Baltimore to Lisbon.
But what if you are sailing from Baltimore to Lisbon? A sailing ship frequently changes course to take advantage of the ever-changing surface winds. The fastest sailing path from Baltimore to Lisbon is unlikely to be the shortest path, but more likely involves tacking back and forth to keep wind in the sails. The airliner’s theoretical “best path” may be irrelevant when captaining a sailing ship.
Managing monetary policy is more like sailing a ship than piloting an airliner. Economic models work best when economic phenomenon are static or slowly-changing. They are not so accurate when conditions are volatile, like swings in business and consumer expectations. The Fed chairman and governors have a better chance at success if they are good at reading markets and correctly anticipating changes in the economic environment instead of fixating on economic theories that may require delays of months for additional data to confirm that changes in policy are warranted.
Some Fed Boards have a good sailing records—Boards under William McChesney Martin (up until the time of President Johnson), Paul Volcker, and Alan Greenspan (up until the early 2000s) were all considered among the best when it came to reading markets and formulating appropriate policy responses. In contrast, Boards under Arthur Burns, Ben Bernanke and Janet Yellen were probably less talented when it came to anticipating economic changes and formulating proactive policy responses.
Apparently, some PhD-dominated boards are good at sailing and others are either unlucky or less attuned to changes in economic winds that drive the economy.
So what are the qualifications needed to be a successful Federal Reserve Board Governor? Today, we have assembled an all-star panel of experts who have agreed to share their views. They are, in the order they will speak, James Grant, Peter Conti-Brown, and Alex Pollock.