Monday, November 18, 2013
Problems in the Great White North
What happens at a regional Federal Reserve Bank? A strength of the Federal Reserve System is that the regional Feds are more or less independent of the Board of Governors in Washington. A Fed President is appointed by the the Bank's Board of Directors, with approval by the Board of Governors, and he or she can shape policy ideas, with the help of staff economists, that compete with the ideas at the Board, and those coming from the other regional Feds. When the Federal Open Market Committee (FOMC) meets, those potentially disparate ideas come together, and if the system works as it should, then the resulting policy decisions are arguably superior to the ones that come out of the centralized central banks that exist in most countries outside the U.S.
But, to shape good policy ideas, a regional Fed President needs advice from serious economists who are up to speed, if not at the frontier, of research in their fields. The most efficient way for economists to stay current is for them to carry on research projects and subject the resulting research to peer review in academic economics journals. Indeed, since the 1970s, Research Departments at Federal Reserve Banks have improved to the point where they can compete successfully for leading economic researchers, and can hold those economists to standards that are comparable to those in leading research universities.
The Federal Reserve Bank of Minneapolis was a leader in bringing cutting edge macroeconomic research into contact with monetary policymaking. Beginning in the early 1970s, the Bank created a relationship with the University of Minnesota. The Bank could provide resources to support research in exchange for the ideas of top academics, those top people would help the Bank to attract other top researchers to serve as full-time economists in the Bank's research department, and the whole research operation could be much better than the sum of its parts. Under the leadership of people like Gary Stern (President from 1985-2009), Art Rolnick, and Warren Weber, research at the Bank flourished - indeed, it was revolutionary. Four people (or more, depending how you count) associated in various ways with the Bank now have Nobel prizes in economics.
A concern at the Minneapolis Fed, just as in any research institution, was what would happen when the management changed. In 2009, with Gary Stern and Art Rolnick retiring, who would run the place? By the fall of 2009, information about who the candidates were had leaked out, and I think there was a collective sigh of relief. In early October of 2009, I went to a conference at the University of Toronto, and Narayana Kocherlakota was there. One night, we had dinner with Narayana, who we knew might be appointed, and we asked him why he wanted to do it. For Narayana, this was a very non-obvious career move. Academics, and Narayana in particular, are looking for intellectual stimulation, and that can't always be had when you're giving speeches to the Rotary Club (no offense to the Rotary Club). Further, academics at the top of the heap typically get somewhat better salaries than do Fed officials. What Narayana said to us in Toronto in early October 2009 was something like: "These are interesting and trying times, and I think I have something to contribute." His primary interest seemed to be having an influence in Washington. In any case, Narayana was appointed as Minneapolis Fed President during the following week.
So, how has that worked out? I discussed some of the issues in a previous post, where I was primarily concerned with Narayana's views on monetary policy. Unfortunately, there's a deeper story here about the health and future of the Minneapolis Fed as a policy institution. In the last weeks, the place has been in turmoil. The internal leadership has been shaken up, and top researchers have been explicitly and implicitly shown the door. All of this has occurred with little warning, or context. The President has done little to articulate a vision for the Minneapolis Fed as a research institution, or a direction for its future. Kocherlakota's interaction with all but a tight inner circle of policy advisers has been reduced to nil, and the top researchers have been made to understand that their input in the policymaking process is not wanted.
Basically, Kocherlakota has declared war on his own research department, and seems intent on destroying the place as a research institution. If this were part of some well-articulated plan or in service of some greater good, maybe we could be convinced, but neither appears to be the case. If the greater good is supposed to be better policy, then it seems that many sharp macroeconomists beg to differ.
So, what's to be done? Like the Mayor of Toronto, Narayana Kocherlakota seems locked in his own bubble. The Mayor of Toronto doesn't seem good for much of anything. He should do the world a favor, resign, and go live as far away from other human beings as possible. Narayana, though, is indeed good for something. He was an excellent academic, and a fine colleague when I worked with him. There are plenty of first rate academic research departments that would be happy to give him a good home. Central banking, however, is not his calling, and he should quit - and do everyone, including himself, a favor.