Monetary policy is at a critical point. The choices made by the Federal Open Market Committee in the next few years will determine if we get inflation under control, how fast our economy grows and what happens in financial markets. We need to be guided by the best economists and experts with deep knowledge of these issues, as well as of the trade-offs that balancing all these challenges pose. This should include at least one person in the group who possesses a deep understanding of the macro economy and how it interacts with financial markets.
But that’s not what we’re getting. President Joe Biden’s latest pick for the Fed’s Board of Governors, Adriana Kugler, is a great labor economist, but the board lacks anyone with financial macro expertise, and that’s what we need to get the economy through this difficult period.
Monetary policy is technical, and expertise in monetary policy and finance is a distinct specialty. Putting an economist who is a micro-theorist on the board is like asking an obstetrician to do open-heart surgery. It’s better to have the obstetrician than someone with no medical training, but you’ll have a better outcome with someone who is an experienced specialist.
The Fed board has often consisted of people with a range of backgrounds. Some were economists, others came from industry and many are lawyers. Members set monetary policy for their entire term. Regional Fed presidents cycle on and off the Federal Open Market Committee for one-year terms, except for the New York Fed president who always gets a vote and usually has a financial background (though current New York president John Williams doesn’t).
Since the 1980s there was usually at least one powerhouse economist with expertise in macro and financial issues on the board. That’s not true today, even though it is arguably more necessary as the Fed has a larger footprint in financial markets. Of the current six members, three have a legal and industry background, including Chairman Jay Powell. The three economists’ research history spans a wide range of topics including some macroeconomics, labor, discrimination and inequality. One board member, Christopher Waller, does have a research background in macro financial issues, but much of his research occurred within the Fed system. An outside perspective is what we need.
The Fed does have a dual mandate to manage inflation and unemployment and some labor expertise is useful. But a board dominated by people more focused on the labor market might reflect political pressure for the Fed to put a bigger weight on employment, especially for disadvantaged communities. But that’s a false choice. People in the 1970s made the same argument and learned the hard way that high, unchecked inflation causes more harm and eventually unemployment, too.
Monetary policy works through financial markets, and understanding the mechanism of how it affects the broader economy is critical to getting it right. Monetary policy is a blunt tool; it’s not well suited to address our inequities. Inequality is an important objective that needs more attention and improved policies, but it’s better handled by the elected government.
Some might assume the choice of Kugler, a Latina, was because of diversity pressures. But there were other excellent economists from diverse backgrounds in the running who have the necessary expertise and could do the job better, as well as make a historic contribution. Janice Eberly or Ricardo Caballero would be a better choice.
The Federal Reserve is facing one of the most challenging periods in its history. The board must balance inflation, the labor market and financial stability. Small and medium-size banks are struggling and may face more pressure with and problems in the commercial real estate market. Inflation is coming down but is still sticky, and doesn’t appear to be reaching the Fed’s 2% target anytime soon.
In the next few years, Fed members may need to decide whether to abandon or change that target or take the economy into a recession to get there. The Fed also has changed its policy tools in the last 15 years, paying interest on reserves and maintaining an enormous balance sheet as part of quantitative easing. That represents a big change in how monetary policy works and how it makes its way through financial markets. Understanding and anticipating how markets will respond takes deep expertise of fixed income and the macro economy.
The Fed can rely on the latest research in these areas, and it’s got access to top scholars for guidance. But it would benefit far more from having one of these scholars on the board, imbedded into its thinking.
The Fed will need intellectual leadership as it strives to end this period of inflation and perhaps start a new philosophical regime in monetary policy marking. Any board member has the potential to help chart that path, but if Biden’s latest nomination sales through confirmation, the Fed will still be missing a crucial piece of the expertise it needs to make the best decisions for the economy.
Allison Schrager is a Bloomberg Opinion columnist covering economics. A senior fellow at the Manhattan Institute, she is author of “An Economist Walks Into a Brothel: And Other Unexpected Places to Understand Risk.”