By Neil Irwin
Washington Post Staff Writer
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.
Some former Fed officials have been even more outspoken in criticizing the intervention. William Poole, who was president of the St. Louis Fed until March, has said that the actions created an "appalling" situation, and Vincent Reinhart, who was a senior staff member until last summer, called it "the worst mistake in a generation." They argue that it set a precedent for government intervention that could have adverse consequences.
There are Fed staff members whose private views are similar to what Poole and Reinhart have said publicly, according to people in close contact with economists in the Federal Reserve system.
Bernanke and his inner circle view these concerns as valid and weighed them heavily in deciding whether to rescue Bear Stearns. But they have said that the price of not acting would have been a global financial catastrophe.
The current Fed system was established in 1913 when Congress, fearful of concentrating financial power in Washington or New York, created regional banks scattered around the country. These banks hold five of the 12 seats at any given time on the Federal Open Market Committee, which decides the nation's monetary policy.
Bernanke has welcomed the resulting debate. He even sees some usefulness in the dissenting votes on interest-rate policy, as these give financial markets a hint of where the committee might adjust its policy in the future.
Gerald Corrigan, the former president of the New York Fed and now a managing partner at Goldman Sachs, said, "One of the great strengths of the Fed policymaking process for as long as I've known it is that you get lots of views from many different perspectives."
Bernanke has set out to encourage more debate than did his predecessor Alan Greenspan. Greenspan spoke first at FOMC meetings, which could create subtle pressure for people to agree with his assessment of the economy and the proper course of action. Bernanke speaks last.
"By his nature and his capacity to appreciate different points of view, Ben would be expected to encourage people to bring different perspectives to the table," said Marvin Goodfriend, a Carnegie Mellon University economist who has known Bernanke for years.
Another difference is the economy itself.
"We had a lot of years in which there wasn't much to disagree about because conditions were very good," said Alice Rivlin, a senior fellow at the Brookings Institution and former Fed vice chairman. "Now we have a very complicated situation. It's not obvious what they should be doing. That's bound to generate more back and forth within the board."
When there were serious disagreements in the 1970s and '80s, they were mostly confined to the giant conference room on Constitution Avenue where the FOMC deliberates. Then, unlike now, the Fed did not immediately announce its rate actions and what the vote was. Presidents of regional banks gave fewer speeches and interviews with reporters. There was no CNBC doing round-the-clock analysis of every comment from Fed officials.
Former Fed leaders said intense debates over policy rarely spill over into personal interactions. Despite the intellectual tension, the FOMC members go to evening receptions where cordiality is the rule.
"If you put the Federal Reserve system on the chalkboard at Harvard Business School, the students would laugh you out of the room," Corrigan said. "But it works."