Why Do the Bankers Decide How Many People Will Be Unemployed?

September 21, 2011

The Federal Reserve Board’s Open Market Committee (FOMC) met today and decided on a modestly expansionary monetary policy. It decided to unload $400 billion worth of short-term assets over the next 9 months and replace them with longer term government bonds. The idea is that this would place some downward pressure on long-term interest rates.

The effect on interest rates and the economy is likely to be very modest. It is unlikely that long-term rates would fall by even 20 basis points (0.2 percentage points) as a result of this action and more likely the effect would be closer to 10 basis points, but at least it is a step in the right direction. This will make it cheaper for people to buy a car or refinance a mortgage. It will also be cheaper for firms to borrow to invest. It would have been good to see stronger action, but this is what the FOMC was prepared to do.

However what was most striking about this decision was the breakdown on the vote. Five of the people voting were members of the board of governors. (There are 7 positions, but 2 are currently vacant.) The governors are appointed by the president and approved by Congress for 14-year terms. Of the 5 sitting governors, 3 were appointed by President Obama, 1 was appointed by President Bush, and 1 governor (Chairman Ben Bernanke) was appointed by both.

The other members of the FOMC are the presidents of the 12 district banks. These presidents are essentially appointed by the banks in the district. All 12 district bank presidents sit in on the FOMC meeting, but only 5 vote at one time.

What was striking about this vote was that all 5 governors voted for this measure obviously feeling that the potential benefits in the form of stronger growth and lower unemployment outweighed any risks of higher inflation. However 3 of the 5 voting bank president opposed the measure, apparently viewing the threat of inflation as being a greater concern than any possible growth and employment dividend.

This raises an obvious question about the interests being represented by the bank presidents. Inflation is especially bad news for banks because it reduces the value of their assets. On the other hand bankers may not be very concerned about unemployment. They have jobs, as is probably the case for most of their friends as well.

It is hard not to wonder whether the bank presidents voting against further steps to spur growth and reduce unemployment were acting in the best interest of the country as a whole or whether they were representing the banks in their district. If the latter is the case, then it is reasonable to ask why we are giving the banks a direct role in setting the country’s monetary policy. There is no obvious reason that they should have any more voice in determining monetary policy than anyone else.

Representative Barney Frank, the ranking Democrat on the House Financial Services Committee, recently proposed a bill that would take away the votes for the bank presidents on the FOMC. This bill deserves some serious consideration.

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