Economic Challenges Draw Out Divisions at Fed
Tuesday, June 24, 2008
As Federal Reserve policymakers sit down this morning to begin deciding whether to adjust interest rates, they do so at a time of exceptional internal disagreement over what approach the central bank should take.
In contrast to the consensus that characterized the Fed for most of the past 20 years, there are now divisions over some of the most fundamental challenges that Fed Chairman Ben S. Bernanke is facing: how to combat the financial crisis, the slumping economy and high inflation.
These divisions are rooted in the structure of the Fed -- which includes 12 regional banks with independent boards of directors, and a central board of governors in Washington chaired by Bernanke -- but have come to the fore only because of the twin problems of weak growth and inflation.
Presidents of the regional banks are appointed by bankers and businesspeople in their communities and, like them, tend to put a premium on keeping inflation in check. The Board of Governors, along with the New York regional bank, has been more attuned to the troubles roiling financial markets, such as those for complicated debt securities and the spillover into the wider economy.
"The presidents bring a wealth of knowledge acquired from their regional contacts," Bernanke said in a speech dedicating the new headquarters of the Kansas City Fed earlier this month.
"Thus, in making policy, we are able to view the economy not just from a Washington perspective or a Wall Street perspective but also from a Main Street perspective."
The resulting differences are usually on subtle points of economic analysis but bubble into bigger disagreements when the economy is weak or inflation is high. Both are now the case, and the core of the debate is which threat the Fed should tackle most aggressively.
The Fed's policymaking body, the Federal Open Market Committee, will consider just that in meetings today and tomorrow in Washington. The committee will probably leave the short-term interest rate it controls unchanged at 2 percent and release a statement indicating heightened worries about inflation.
Over the past 10 months, Bernanke and a majority of his colleagues cut that interest rate aggressively to try to prevent a deep recession. But at least one member of the committee has dissented in each of the last seven interest-rate votes and two each at the two most recent meetings.
Several members, notably the presidents of regional Federal Reserve banks in Dallas, Philadelphia, Richmond, Kansas City and St. Louis, have repeatedly argued that inflation is a rising threat, suggesting that the Fed should not have cut rates as much and should now consider raising them. Richard Fisher, the Dallas Fed president, earlier this month praised European Central Bank President Jean-Claude Trichet for raising rates, drawing an implicit contrast with Bernanke's cuts.
There has also been disagreement over the Fed's unprecedented actions to stabilize the financial system this spring. These included extending emergency loans to investment banks and engineering the takeover of Wall Street firm Bear Stearns, which had been on the brink of bankruptcy. Bernanke and New York Fed President Timothy Geithner led that middle-of-the-night rescue effort without the involvement of officials from other regional Fed banks.
Presidents of four regional Fed banks have in recent weeks publicly voiced concern, most explicitly by Richmond Fed President Jeffrey M. Lacker, that these efforts by their colleagues in Washington and New York created risks of their own.