Stanley Fischer's Departure Reveals Weakness at the Fed

The early resignation of Stanley Fischer, the Federal Reserve board vice-chairman, is a reminder that the coming turnover in the Fed's leadership is unprecedented in speed and scale. For all the attacks on the Fed since 2008 nothing has really changed in terms of its governance or accountability. Mr. Fischer's resignation, however, reveals one weakness in the organization to remedy, and one under-appreciated strength to retain.

First, the strength. The Federal Reserve Bank presidents will become extremely important as a bulwark against a potentially radical shift in the board of governors. This is how the system should work. We need some independence against groupthink imposed from Washington, and some longer term institutional memory. We can still reform how FR Bank presidents are chosen within districts, to reduce private-sector banks' influence. But the independence from Washington of the FR Bank presidents is worth preserving.

This will be more important in the coming years on the bank supervision and financial regulation side of the job than on the monetary policy side. Bravery and resolution by the FR Bank presidents is called for to stand up against what is likely to be a campaign not only to roll back bank regulation beyond what is justified, but also to go harmfully "light touch" in the implementation of bank supervision and the interpretation of regulations.

This is the weakness of the system. The Federal Reserve board has too much discretion in how any regulations and supervisory rules are applied. The FR Bank presidents have some room and a mandate to provide an independent assessment of financial stability and of bank health in their districts. They will have to speak truth to power and to the public.

The president of the Federal Reserve Bank of New York has potential to be a real problem in this regard (I refer to a structural problem, not to the current or likely coming occupant as individuals). Normally the FRBNY president stands shoulder to shoulder with the chair and vice-chair on monetary policy, which is not, on balance, useful. In recent years, this norm has unfortunately tended to lead either to unanimity on major financial issues or (worse) the rest of the board deferring to the FRBNY president on the massive financial oversight and interpretation in her district's remit.

There is a legitimate concern that the Fed NY president is subject to cognitive capture by the leading financial firms. We saw instances of this in the 1990s and again in the aftermath of the global financial crisis. For a variety of reasons, that seems to be less of a problem with other FR Bank presidents. This is why I have been in favor of efforts to reduce the supervisory role of the FRBNY president vis-à-vis the other reserve banks, and its outsize representation in international forums.

There would be nothing wrong with allowing the FRBNY president to dissent on monetary policy in return. The norm on the Federal Open Market Committee (FOMC) of limiting dissent on any monetary policy vote, and the FRBNY president never dissenting, is contrary to the spirit of what Fed debate over policy should be. It also gives too much power to the chair, and deprives the public of information and accountability. In the Bank of England's Monetary Policy Committee, the governor is allowed to be outvoted.

The dangers posed by the Fed board having too much discretion over financial regulation will be made worse if the Republican majority in Congress, with some support from some leftwing Democrats, continue to limit the Fed's ability to intervene in markets. I fear that the banking deregulation push, combined with some sop to anti-Fed populism, may well produce such a result.

This is why macroprudential policy, and financial supervision in general, should be more rules-based and allow less discretion to central bankers.

The current design of the FOMC and the Federal Reserve system which ensures a majority of independent Reserve Bank presidents will be more important than ever, given the rapid turnover of the majority of the board of governors. When the time comes to redesign the Fed, part of the reform should be to reduce the discretion of all Fed officials, including the chair, the vice-chair for supervision and the FRBNY president, in the interpretation and implementation of financial policy.