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The Greenspan Temptation

WASHINGTON, DC – The drafters of the United States Constitution had to make a fundamental choice: Should they concentrate power in the hands of one man, or devise a political system in which decision-making influence would be more diffuse? A similar choice now faces US President Barack Obama as he considers who should succeed Ben Bernanke as Chairman of the Board of Governors of the Federal Reserve System.

Bernanke’s legacy is decidedly mixed, but its most appealing feature is the ethos of collegiality and shared responsibility that he encouraged at the Fed. Indeed, a key goal for his successor should be to cement this approach as a new institutional tradition.

Yet a strong inclination toward an all-powerful Fed chairman is apparent both from history and from trial balloons recently floated by the Obama administration. The Federal Reserve Board comprises seven governors; but, for most of its history, the Board has operated in the shadow of its chairmen, three of whom (Marriner Eccles, William McChesney Martin, and, most recently, Alan Greenspan) served for nearly 20 years.

Monetary policy is, in principle, decided by the Federal Open Market Committee, which includes 12 voting members: the seven Fed governors, the president of the New York Fed, and four presidents of the other 11 regional Federal Reserve Banks (who serve on a one-year rotating basis). In practice, however, Greenspan and many of his predecessors came to dominate the FOMC.

What’s wrong with an omnipotent Fed chairman? Start by considering the lasting impact of Greenspan, who believed deeply that financial deregulation would contribute to more stable economic growth. As he put it in 1997, “As we move into a new century, the market-stabilizing private regulatory forces should gradually displace many cumbersome, increasingly ineffective government structures.”

Greenspan left office in 2006, but the crisis that soon followed can be attributed in large part to the kind of financial innovation that he encouraged. By 2008, in congressional testimony, Greenspan was willing to concede a fatal flaw in his thinking – deregulated financial markets can indeed go badly wrong.

In a situation that demands fast and bold decision-making, someone has to be in charge. The Continental Congress did well when, in 1775, it asked George Washington to lead the forces then gathering in rebellion against the British. But Washington, in turn, was wise to decline authoritarian powers following independence – and again when he resigned after eight years as the new country’s first president.

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The modern financial world is fast-moving and complex. The next chairman will have to move decisively to persuade colleagues when needed; but, first and foremost, he or she will need a heavy dose of humility and respect for the views of his or her peers.

Monetary policy involves a significant amount of art, as well as some science. And our understanding of “macro-prudential regulation” and how that affects financial stability is still at a very early stage. The consequences of poorly understood interconnections among countries have repeatedly blind-sided the world’s major central banks – consider the euro crisis or European banks’ heavy reliance on financing from US-based money-market funds.

The next Fed chairman should be someone with an open mind, a willingness to engage the staff, and a desire to cultivate expertise throughout the Federal Reserve System. The worst possible outcome would be to pick someone who shares Greenspan’s inclinations – holding data tightly, monopolizing decision-making, and attempting to overawe colleagues.

A 20-year tenure for such a person would be a recipe for economic disaster, which would no doubt begin with some form of financial crisis. But that would not be the worst of the danger. There would also be insistent calls for curtailing the Federal Reserve’s powers or limiting its independence from Congress.

Countries have experimented with allowing politicians to control monetary policy on a day-to-day basis. It never ends well – politicians simply find it too tempting to juice the economy in the run-up to an election or at other politically important moments.

Rather than playing with fire by proposing a Fed chairman who would aspire to become a dominant figure, perhaps the Obama administration should consider a term limit on the Fed chairman (say, eight years). Term limits improve governance in some other official US agencies and elsewhere.

The problem is that once reform of the Fed is on the table, all kinds of other ideas will surface. The randomness of the political process could easily produce outcomes that reduce its independence. That is why the Fed chairman’s leadership style is so important.

Ben Bernanke made mistakes – including thinking too much like Greenspan in the run-up to the catastrophe of 2008. But he also established the rudiments of a more collegial and balanced decision-making process within the Fed. His successor should be chosen with the goal of building on this achievement.

Simon Johnson is a professor at MIT’s Sloan School of Management and the co-author of White House Burning: The Founding Fathers, Our National Debt, And Why It Matters To You.

Copyright: Project Syndicate, 2013.

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