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The understaffed Fed: What it really means

By Neil Irwin

Since Don Kohn retired from the Federal Reserve Board of Governors on Sept. 1, the central bank has been severely understaffed in its executive ranks. (Only four of seven governor slots are currently filled; there are two long-vacant slots besides Kohn's newly vacated seat). President Obama nominated three new governors in April and they were each handily approved by the Senate Banking Committee over the summer, but the Senate has not held confirmation votes, and doesn't appear poised to anytime soon. ("We've got a limited amount of time here, I don't know if there's going to be any appetite to deal with these Fed nominees," said Sen. Christopher Dodd (D-Conn.) recently).

So what does that mean for the functioning of the Fed? It's not good.

Each of the Fed governors has some administrative responsibility over a key area of the central bank. Banking expert Dan Tarullo, for example, oversees bank supervision, and Elizabeth Duke oversees consumer protection matters. Kohn, who was vice chairman until June, had a particularly large portfolio. He was in charge of the research divisions of the Fed -- the economists in monetary affairs, research and statistics, and international divisions who prepare the analysis that Fed leaders use to make policy decisions. And he also oversaw matters involving the regional Fed banks across the country, approving their budgets, major operational decisions, and who would be on their boards of directors. If the vacancies persist, it would cause significant operational strains as the remaining governors are stretched thin, and important administrative aspects of running an institution with almost 2,000 employees in Washington (and another 16,000 around the country) could easily fall by the wayside.

Then there's monetary policy, the Fed's core function. There is now a strange situation in that the institution in charge of guiding the U.S. economy has only one PhD economist among its top officials, Chairman Ben S. Bernanke. The other three currently serving governors are not monetary policy specialists (they are Tarullo, a former law professor, Duke, a former banker, and Kevin Warsh, a financial markets expert). Two of Obama's nominees are economists, San Francisco Fed president Janet Yellen and MIT professor Peter Diamond. This is, as it happens, a pretty terrible time for the Fed not to have as many smart economists in its upper ranks as possible; the central bank faces a massively consequential decision over the coming months of whether to undertake new steps to try to boost the economy.

That said, it is probably not the case that Bernanke needs for the new appointees to be confirmed before undertaking new action. Most of the members of the Fed's policy-setting committee will show strong deference to Bernanke's judgment, and if he decides that the central bank should buy hundreds of billions of dollars of bonds to try to stimulate growth, most of the Federal Open Market Committee will follow his lead. Still, Washington-based Fed governors tend to ally themselves with whatever the chairman's position is on monetary policy, and having more officials in the room who see the world the way Bernanke does would likely shift the intellectual center of gravity on policy discussions, and put the handful of presidents of regional Fed banks who are strongly opposed to any new action more clearly in the minority camp. But ultimately this will be the chairman's call, and if he decides to pull the trigger on new bond purchases, there's not much doubt that he will get his way even in the absence of newly confirmed governors.

Some commentators have suggested a third reason that having an under-staffed Fed could be problematic. The emergency lending authority that the Fed used repeatedly in 2008 as part of its response to the financial crisis requires a vote of at least five governors to be invoked, which would suggest that the Fed's hands would be tied if a return to crisis conditions occurred and new emergency action were called for. But this isn't quite right. Under a provision enacted after the Sept. 11 terrorist attacks, it is possible to invoke the emergency lending authorities even with fewer than five governors.

To be precise, Section 11(r) of the Federal Reserve Act allows the Fed to do emergency lending by unanimous vote when there are fewer than five members in office or available. It was invoked, incidentally, to allow the Bear Stearns bailout in March 2008. Only four governors of the five then in office approved that emergency lending, because then-governor Frederic Mishkin was on an overnight flight during the early morning hours that the loan was approved.

Still, the Senate's sluggishness has left the Fed short-staffed at a time it has weighty, complex and massively important issues on its plate.

By Neil Irwin  |  September 17, 2010; 8:00 AM ET
Categories:  Federal Reserve  
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"Then there's monetary policy, the Fed's core function. There is now a strange situation in that the institution in charge of guiding the U.S. economy has only one PhD economist among its top officials, Chairman Ben S. Bernanke."

...and apparently, having a PhD doesn't necessarily mean that one understands why the monetary policy that the Fed has been following appears not to be working.

Posted by: Baywoodfarm | September 17, 2010 9:03 AM | Report abuse

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