As you may have noticed, we've been a little obsessed here at Wonkblog with the impending selection of a new chairman of the Federal Reserve. A week ago it looked like it would probably be Larry Summers. Now it looks like it will probably be Janet Yellen.
But maybe it's time to back up a little. There are some basics about the Fed, and the job leading it, that nobody ever really gets around to explaining. With an appreciative hat tip to our colleague Max Fisher's Syria explainer, which we are going to blatantly rip off, we now bring you the very, very basics about the Federal Reserve and the Fed chairmanship.
What is the Federal Reserve?
The Fed, as it is often called, is the nation's central bank. It controls the supply of money in the U.S. economy. The $20 bill in your wallet can be used to buy things because the Fed says so (Look! It even says "Federal Reserve Note" at the top).
The Fed also regulates thousands of private banks around the country and is ready to make emergency loans to them if they temporarily run short of cash. And it manages the technical plumbing that ensures that banks have plenty of money on hand to fill up their cash machines and makes sure that when your employer tries to electronically transfer your paycheck every other Friday, the money shows up in your checking account.
The Federal Reserve System includes the Board of Governors, based on Constitution Avenue in Washington, and a dozen reserve banks based around the country, plus 20 smaller branch locations. It’s pretty huge: The Federal Reserve System has around 20,000 employees and $2.3 billion worth of real estate. It had $3.7 trillion on its books at last count.
So, the chairman of the Federal Reserve is in charge of all that?
Yes and no. The chair, currently Ben S. Bernanke, is definitely the most powerful person in the system, and bears ultimate responsibility for the Fed’s successes and failures. But he or she doesn’t have the run of the place like a corporate CEO. Simply put, the Fed chair isn’t the boss, in any conventional sense of the term, of most of the people he or she relies on to run that sprawling system. Rather, the chair is a first among equals.
The system is headed by a seven-member Board of Governors, led by the chair. While those governors tend to be deferential toward the chairman’s wishes, each is independently appointed by the president and has every right to dissent when he or she disagrees with a decision, whether on bank regulation or interest rate policy. Similarly, the 12 reserve banks are each run by a president, who in turn is chosen by local boards of directors of each reserve bank, with the selection subject to the approval of the board of governors.
It is a messy system. The chairman of the Fed actually is like a CEO, but a CEO of a very strange company: a company where someone other than the CEO selects all the division heads, and where the CEO himself can’t fire them.
In some ways it more closely resembles being the president of a university, a job in which various deans exercise most of the day-to-day management of the institution and tenured faculty exert significant influence but can't be fired.
The Fed chair cannot just command. He or she must lead by persuasion and more subtle forms of authority.
What does that mean, subtle forms of authority?
Well, for example, one of the most important jobs of the Fed is to decide how much money there should be in the economy -- too much, and there will be inflation; too little, and there will be high unemployment. They make these decisions eight times a year in Washington, in the Federal Open Market Committee, which includes all seven governors and all 12 reserve bank presidents (only five of whom have a vote at one time).
In theory, the chairman holds one of 12 votes to decide what those decisions ought to be. But in practice, he or she has much more influence than that would suggest. The chair sets the agenda — which issues in the economy are worthy of discussion and consideration and which aren’t. The chair oversees the staff members who prepare the forecasts on which the decisions are based. The chair determines who talks and when and for how long. As a matter of tradition, committee members don't dissent unless they strongly disagree with the direction the rest of the committee is heading. Through the nearly eight years of the Bernanke chairmanship there have never been more than three dissenters at one meeting.
But if most of the other members of the committee strongly disagreed with the chair’s direction, it could can get really nasty. In 1986 Fed Chairman Paul Volcker threatened to resign unless four governors newly appointed by President Ronald Reagan came around to his way of thinking. They did.
That's a lot of words. Can we get a Fed-related musical interlude?
So what does the Fed chair actually do all day?
Meetings, mostly, with a good bit of thinking thrown in. With the administrative tasks of running the Fed largely handled by other people, the Fed chief is much more an intellectual leader than day-to-day manager.
While a new Fed chair could choose to organize her or his time differently, both Bernanke and his predecessor, Alan Greenspan, kept a relatively loose schedule, with long stretches of the day reserved for reading incoming economic data and analysis and reports from the various divisions of the Fed that report to them. The press focuses mostly on their U.S. monetary policy decisions, but they also have to be up to speed on an almost infinite variety of bank regulatory issues, international economic trends and relations with Congress, the administration and other agencies.
Greenspan famously digested all this information in part during long morning baths; Bernanke comes in most weekend days for several hours to read in the comfort of jeans and the quiet of a mostly empty building. His bathing habits are not publicly known.
For a sense of how the Fed chair uses his time differently from other key U.S. economic policymakers, here are the calendars of both Bernanke and former Treasury secretary Timothy Geithner for the same random day (March 17, 2011).
As we see, Bernanke’s schedule is less frenetic, with more time built in for thinking and mulling. (And, no, Bernanke's "Staff Literature Discussion" is not a book club, and definitely does not include "50 Shades of Gray"; it is for review of the latest economic research by Fed staff.)
Between meetings, when the chair isn't reading reports and scratching his or her chin in deep thought, he or she is probably responding to e-mails, having brief, informal conversations with senior staff that don't show up on the official schedule, and checking the Bloomberg data terminal to monitor financial markets.
What does the Fed have to do with politics?
It’s complicated! The president appoints the Fed chair (subject to Senate confirmation) but can’t fire him or her. Congress can yell at them to do this or that (indeed, legally the Fed chair must go before Congress at least twice a year, and in practice it’s usually more often than that). But Congress can’t fire them, either.
And unlike most agencies, Congress can’t even mess with the Fed by threatening to withhold funding. Printing money, as it turns out, is a profitable business, so the Fed pays its operating expenses — buildings, salaries, and so on — out of those earnings, and then refunds whatever is left over to Congress. So the Fed helps fund Congress, not the other way around.
The reason for that insulation is that the job the Fed has to do is complex (do you really want to trust Congress to decide how to calculate capital levels for giant banks?) and benefits from being separate from politics. A president typically has every incentive to encourage low interest rates in the run-up to an election, for instance, even though it could come at the cost of unpleasant and self-defeating inflation over the long run. Independence cuts both ways, though! In recent years, the Bernanke Fed has shown a willingness to move toward easier monetary policy, even over the objections of many congressional Republicans.
Some Fed chairmen have been closer to the governments they served, others not so much. Arthur Burns, the chairman in the 1970s, was so close to the Nixon administration that in private Oval Office sessions he spoke as if they were part of the same team, trying to goose the economy in the run-up to the 1972 election. (The seeds of the high inflation of the late 1970s were sown then).
Since Burns, there has been more Fed independence, sometimes sparking tension. Many aides in the Reagan administration were frustrated with Paul Volcker’s tight money policies, and Volcker took holy hell from homebuilding industries and others stung by high interest rates (if you're the next Fed chair, ask Bernanke to pass along the 2x4 board mailed to Volcker in protest, which still sits in the chairman's office). The tension between the George H.W. Bush administration and Greenspan was legendary.
But the last three presidents — Clinton, George W. Bush and Obama — have settled into a more agreeable routine with the Fed, in which they do not comment on monetary policy or try to explicitly tell the central bank what to do.
On a practical level, the Fed chair has, in these recent administrations, stayed on close terms with the Treasury secretary, typically eating a meal together once a week. They maintain cordial, if more distant, relations with the president himself, meeting every few months.
The Fed chair plays a symbolic role as the nation's economist-in-chief, and must always make decisions over how much to speak about economic subjects that are outside the Fed's immediate focus. In Congressional hearings, lawmakers frequently try to get the Fed chair to endorse their preferred policies
So, the Fed regulates banks. What does that mean in practice?
In years past, this seemed like a bit of an afterthought, or at least not the main focus of the Federal Reserve chair. It was the kind of thing you shunted off to a deputy.
Since the financial crisis, we've seen how important regulating the nation’s banks and other financial institutions is for maintaining a stable economy. Bernanke has spent significantly more time monitoring and learning about bank supervision in the last few years than he did when he first started the job or Greenspan did before him.
For whoever ends up in the job next, the thing to remember is this: If you don’t get financial regulation right, all the other stuff you do with monetary policy to try to keep inflation and unemployment low will be for nought.
And you said something about an international role?
In that schedule above it looked like Bernanke spent his entire evening on a G7 conference call. They weren't talking about the newest model of Gulfstream Jet. It was, of course, the Group of Seven finance ministers and central bankers of leading industrialized countries.
So yeah, this is another really big part of the job that doesn’t show up in the headlines very much. As the last few years have made abundantly clear, what the United States does matters a lot for other countries’ economies, and what other countries do matters for ours.
The Fed chair spends a lot of time talking to his or her counterparts around the world, particularly at other central banks but also at various global bank regulators and finance ministries and international organizations.
Part of this is informational. The Fed chair is just trying to assess the state of different countries’ economies and financial systems to understand how they might affect the United States. But there is policy coordination, as well. The global bank regulators negotiate common capital standards for the biggest global banks and during the crisis used “international liquidity swap lines,” which were coordinated actions to try to ensure the free flow of cash around the world.
How powerful is the Fed chair, really? No, seriously, I want a ranking.
Oh, you want power rankings? I’d put the Fed chair at the second most powerful person in the United States. The president comes first. But consider the alternatives for the No. 2 slot: The vice president’s only formal power is to break ties in the Senate; the president can choose to ignore and marginalize him. High Cabinet officials like the secretaries of state and defense take their orders from, and serve at the pleasure of, the president. Similarly, you could make a case for White House chief of staff, but that position is basically a vessel for carrying out the president's wishes. The chief justice of the Supreme Court is both powerful and independent, but is much more likely to be outvoted by peers than is the Fed chair.
So, there you go: The chairman of the Federal Reserve is the second most powerful person in the nation. Globally, such a ranking would be even more subjective, but we'd put the Fed chair somewhere below the heads of state of the major global powers like the United States, Russia and China, along with those of mid-size powers like Japan, Brazil, Germany and France. But in any global power rankings, the Fed chair should be in the next tier, putting him or her somewhere in the 10 to 15 ballpark in ranking.
That would make Yellen the third most powerful woman in the world if she gets the job, behind German Chancellor Angela Merkel and Brazilian President Dilma Rousseff.
So, I guess we should really care who gets the job?
Yes. Yes, you should. With the signs pointing to a Yellen appointment, you can read more about the current Fed vice chairwoman here. It appears the other candidate still in the running is former vice chairman Don Kohn; read more about him here. Long-shot candidates could Roger Ferguson or Stan Fischer.
How about another money-related song?