In his most recent blog post, former Fed chair Ben Bernanke takes umbrage at an op-ed by the Wall Street Journal’s Benn Steil. In the Tuesday op-ed titled “Misreading the Fed on a Rate Increase”, Steil argues that Fed-watchers should be paying less attention to the views of members of the Federal Open Market Committee (FOMC), and more attention to the Fed’s Board of Governors, the part of the Fed that is based in Washington DC.
Benn Steil’s argument on FOMC versus Fed Board
The first point Bernanke makes is that is Steil is not really talking about the influence of individual participants in FOMC decisions, but is instead making a more technical point. Steil’s argument goes that, given the Fed’s large balance sheet today, typical methods of managing the federal funds rate will not work. In order to raise the federal funds rate here in the near future, the Fed will have to rely on new tools to get the job done. These tools may include changes in the rate of interest it pays on reserves held by commercial banks. The law that gave the Fed the power to pay interest on bank reserves gave the authority to set the rate to the Fed Board, not the FOMC. Therefore, Steil says that the Board and not the FOMC really controls monetary policy.
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Ben Bernanke’s rebuttal
Ben Bernanke says that Steil is basing his argument on a technicality rather than the practical reality of the situation. He notes: “Whatever the technicalities, Fed policymakers know that the expectation of the Congress and the public is that monetary policy will be made by the FOMC, not the Board—an expectation reinforced by decades of Fed practice. During my time as chair (of both the Board and the FOMC), we were explicit both internally and externally about the primacy of the FOMC in monetary policy, an understanding that was fully supported by members of the Board as well as by other FOMC participants.”
According to Ben Bernanke, there is also historical precedent for the Fed Board having “technical authorities” that in were typically subordinated to FOMC decisions. For example, the Board has the authority to set the discount rate, ie, the interest rate at which regional Reserve Banks lend to banks in their district. However, the Board has not used its authority over the discount rate to try to exert an independent influence on monetary policy; instead, when the FOMC changed its fund rate target, the Board always went along and changed the discount rate to match the FOMC’s action.
Ben Bernanke concludes his piece by telling readers they would be wise to continue to focus on the FOMC. “If you want to understand and predict Fed decisions on interest rates, you will be well advised to follow the debates among the FOMC and its leadership. The views of Board members are relevant, of course, but because Board members are also voters on the FOMC, not because there is any risk that the Board will try to block implementation of an FOMC decision.”