This commentary was written by Dr. Daniel Thornton of D.L. Thornton Economics. Thornton spent over three decades at the St. Louis Fed as vice president and economic advisor.
In a Wall Street Journal op-ed on May 5, here, Judy Shelton, a nominee for Governor of the Federal Reserve who wasn’t confirmed, suggested groupthink permeates the Federal Reserve Board of Governors. She noted that no governor has dissented since 2013.
The lack of dissent by Fed governors is not a recent development. In research I conducted with David Wheelock here, we found that there were only two dissents by governors since 1995.
We also found that governors tended to dissent in favor of easier policy while Reserve Bank Presidents dissented in favor of tight policy; the two dissents by governors since 1995 were for easier policy.
But groupthink at the Fed goes far beyond the lack of dissents. The Federal Open Market Committee (FOMC) is dominated by PhD economists. Of the six Governors, four are PhD economists (there is one vacancy on the Board of Governors).
Of the 12 Federal Reserve Presidents, eight are PhD economists. This would not be a problem were not for the fact that macroeconomics has converged around the same basic model and policy framework.
There are no longer fundamental debates about policy. The last fundamental debate occurred at the March 2009 FOMC meeting when Chairman Ben Bernanke introduced his version of quantitative easing, QE. With the federal funds rate at zero, Bernanke suggested the Fed purchase long-term securities to push long-term interest rates down in order to stimulate spending.
Several Reserve Bank Presidents, in particular, Charles Plosser, Thomas Hoenig, Charles Evans, Gary Stern and Jeffery Lacker were skeptical about engaging in credit allocation—that is, providing credit to specific segments of the market. They preferred the Fed’s historical approach.
Historically, the Fed purchased very short-term Treasury bills to minimize the effect of its security purchases on interest rates and let the market determine how the additional credit the Fed supplied be distributed.
Plosser said that providing credit to certain segments of the market was “the Treasury’s responsibility,” that is, fiscal policy. Stern expressed that if credit allocation went too far it would “interfere with what would otherwise be normal and healthy market adjustment.” None of the Governors voiced any concern.
Since the mid-1980s, monetary policy has only been about interest rates. Policymakers believe that the only way the Fed can stimulate spending is by reducing interest rates. With the federal funds rate at essentially zero, they believed there was nothing else they could do.
The FOMC voted to purchase $1.15 trillion of long-term Treasuries, mortgage-backed securities and agency debt in addition to the $600 billion of securities the Board of Governors had committed the Fed to purchase on November 25, 2008. Evans and Lacker were voting members at the time, but neither dissented.
That dissents are not about important policy issues is illustrated by the “policy debate” at the August 2011 FOMC meeting. A proposal was made to strengthen the FOMC’s forward guidance policy [forward guidance is the idea the Fed federal funds rate policy would have a larger effect on long-term rates if the FOMC committed to keep the funds rate at zero longer than market participants would expect otherwise.]
In order for forward guidance to be effective, the FOMC’s commitment to keep the federal funds rate low must credible—market participants must believe that the FOMC won’t renege. The proposal was that the FOMC’s statement read: the Committee anticipates that economic conditions “are likely to warrant exceptionally low levels of the fund rate at least through mid-2013.”
The debate that ensued was about whether the FOMC’s forward guidance policy should be “state contingent,” that is, conditional on some economic event, rather than “time contingent.”
There was no real fundamental policy debate, i.e., a debate about the desirability of the policy or whether it will succeed in reducing longer-term rates, or the possibility that forward guidance could led to instability.
For example, if the economy were to improve before the calendar date or the contingency was met or inflation began to accelerate, forward guidance would force the FOMC to keep the federal funds rate low.
If the FOMC changed policy, it would lose credibility generally and would never be able to use forward guidance again. If it stuck to its policy to maintain its credibility, policy would be far too easy.
In any event, three Reserve Bank presidents dissented in favor of the phrase “economic conditions are likely to warrant exceptionally low levels for the federal funds rate for an extended period.”
A digression: At its November 2012 meeting the FOMC adopted state-contingent forward guidance stating that it anticipates that the federal funds rate will remain exceptionally low “at least as long as the unemployment rate remains above 6-1/2 percent.”
I published a Federal Reserve Bank of St. Louis Economic Synopses here suggesting that the Fed shouldn’t make its forward guidance policy based on something it cannot control. At its March 2014 meeting the FOMC said “With the unemployment rate nearing 6-1/2 percent, the Committee has updated its forward guidance.”
The decline in the unemployment rate was largely due to people leaving the labor force, not to a strong surge in employment. The FOMC’s forward guidance statement read: “When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.” In other words, ‘we will raise our funds rate target when we decide to.’
Goodbye forward guidance!
More disturbing is the fact that there was never a careful evaluation of the efficacy of QE after it was implemented. Immediately following the QE announcement on March 18, 2009, the 10-year Treasury rate declined 51 basis points.
At the April meeting, Janet Yellen, then president of the Federal Reserve Bank of San Francisco, said there was “compelling evidence that purchases of longer-term Treasury securities worked to bring down borrowing rates and improved financial conditions more broadly,” and that, having “tested the waters,” it was time for the Fed “to wade in by substantially increasing our purchases of Treasury securities.” However, by the June 2009 meeting the 10-year Treasury rate was 121 basis points higher than it was the day before the FOMC’s QE announcement, and Yellen had changed her tune, saying:
Initially I was an enthusiast for long-term Treasury purchases. I thought the purpose of it was not only to improve liquidity and market functioning, but also to influence yields to push them down…
On theoretical grounds, I believe there’s a very strong case that they should have some effect, but it has been awfully hard to identify exactly what that effect is, and I think that we’re beginning to run into costs of pursuing that further…I would say the benefits don’t merit the costs, but I wouldn’t want to see Treasuries taken off the table if conditions were to deteriorate and attitudes were to change.
Despite the lack of compelling evidence that QE has not reduced long-term yields (for some of the evidence, see Requiem for QE pp. 16-22), the FOMC have continued to purchase more Treasuries and other debt. The Fed continued this practice under Yellen and Powell. Moreover, I’m not aware of any Committee member who has expressed concern that the Fed currently holds 23% of all marketable Treasury securities.
Judy Shelton’s views are nonconventional. This is the reason she was not confirmed.
While I don’t agree with her views generally, she would have been a healthy addition to the policy debate. Instead of quashing alternative points of view, as the Fed and the economics profession has actively tried to do, the Fed should encourage alternative views and debate. It would be great if Congress did this too.
If it had, Shelton might have been confirmed. President Biden would do well to nominate someone who will stir up real fundamental policy debate at FOMC meetings.
EDITOR'S NOTE
This is a Hedgeye Guest Contributor piece written by Dr. Daniel Thornton. During his 33-year career at the St. Louis Fed, Thornton served as vice president and economic advisor. He currently runs D.L. Thornton Economics, an economic research consultancy. This piece does not necessarily reflect the opinion of Hedgeye.
