The Fed Chair Matters Less Than the Rules They Follow

Norbert J. Michel

Last week’s confrimation hearing for Kevin Warsh, the nominee to be the next chair of the Federal Reserve, drew tons of attention regarding the Fed’s independence. Economist Paul Krugman, for instance, thinks that Warsh is “Trump’s sock puppet.” Warsh, of course, says that he won’t just do Trump’s bidding.

Once he’s in, I can’t imagine Warsh being anyone’s sock puppet. He’s a former Fed Board governor who’s been actively seeking the Fed chairmanship for years. It’s a safe bet that he’ll be a Fed-first guy, and the institutional structure makes that easy. The Fed is a committee/consensus-driven bureaucracy, and it will be nearly impossible for any single person to force the Federal Open Market Committee (FOMC) to do anything.

All this independence stuff is more of a sideshow.

The most interesting thing to come out of the hearing was Sen. Kevin Cramer’s (R‑ND) pronouncement that “we should just have an AI Fed chairman. That way it’d be completely neutral.” I’m not so sure Sen. Cramer was serious about instituting this kind of policy, but as the Washington Post’s Dominic Pino so nicely put it: Yes!

The idea is very similar to what Milton Friedman once proposed. At one point, he even suggested replacing the Fed with a computer:

This computer would have one task: Print out the same amount of money, month after month, year after year. There wouldn’t be much work for central bankers, except perhaps as IT personnel.

This idea has evolved a bit, and now many economists (my colleague Jai Kedia and I included) advocate using a monetary policy rule. But much like when Friedman first proposed a constant growth rule, the precise details of the policy rule would be less important than having a rule to begin with.

Rather than giving the FOMC total discretion, a rule would keep the central bank within certain limits. It would allow people to readily form reasonable expectations about the future course of monetary policy.

Many people, especially central bankers, object to these kinds of policy rules. They say that they need maximum discretion to deal with unanticipated slowdowns, emergencies, and crises. But the evidence does not favor the pro-discretion crowd. For example, after the Fed exercised its enormous discretion in the wake of the 2008 financial crisis and the 2020 COVID-19 shutdowns, the economy still suffered from a prolonged slowdown and high inflation, respectively.

Moreover, nothing that the Fed did couldn’t have been achieved through congressional appropriations. Arguably, for a democracy, the best way to provide all that government support would have been through Congress instead of through a bunch of murky “facilities” run by a quasi-independent branch of the federal government. It certainly would have been easier to hold Congress accountable.

Regardless, monetary policy should be clear, concise, predictable, and as immune to political pressure as possible. These traits are best achieved by eliminating much of the Fed’s discretionary authority and requiring it to set its interest rate target using a policy rule.

That’s what Congress should be focused on, not the media circus the Trump administration has created around Fed independence. The Fed serves the public best when it does less, not more.

This post is cross-posted from Norbert Michel’s Substack, Mind The Gap.

Source: https://www.cato.org/blog/fed-chair-matters-less-rules-they-follow