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The Fed needs diversity of thought

President Joe Biden has nominated three smart, diverse candidates to fill vacancies on the Federal Reserve Board of Governors. Predictably, Republicans are already complaining about their views, particularly those of Sarah Bloom Raskin, the nominee for vice-chair of supervision, who has expressed concern about the effects of climate change on financial stability and has an interest in the risks posed by shadow banking, cryptocurrencies and cyber security. Conservatives say her appointment would “politicise bank supervision”.

The arguments are cynical and flawed. For starters, the notion of “politicising” the Fed ignores the fact that it has for several decades now been increasingly political, in the sense that central bankers have, by choice and by force, become the chief economic actors in the country.

From Alan Greenspan onwards, the Fed has successfully used low interest rates to bolster asset prices and stretch out the business cycle. Average recovery cycles have been expanding since 1982. This has made it convenient for politicians of both parties not to take hard decisions that involve trade-offs between interest groups. Instead, they kick the responsibility for keeping an economy increasingly driven by asset price inflation, rather than by productivity and wage growth, over to the Fed.

This dysfunctional dance sped up after the 2008 financial crisis and even more so after 2010, when the Fed’s quantitative easing programme expanded. Monetary policy, not fiscal policy, has driven the recovery since. Biden tried to change this, with his Build Back Better agenda. But polarised politics in Congress mean passing serious, long-term fiscal stimulus is tougher than ever. This puts more political pressure on the Fed.

Inflation has forced the central bank to start winding back its easy money policies, at least for now. This will ultimately have some big market impacts. Over the past decade, financial risk has migrated from the traditional banking sector towards areas like private equity, non-financial corporations and fintech. It’s the right time to think about expanding the mandate of the types of risks that the Fed looks at — from cyber, crypto and climate to geopolitics.

In fact, this was already happening under Randy Quarles, vice chair of supervision under President Donald Trump. He chaired the Financial Stability Board, the international body that co-ordinates national financial regulation, in July 2021 when it put out a white paper addressing climate-related financial risks. This stuff simply isn’t as controversial as Republicans say it is.

Meanwhile, industry is moving ahead of regulators and politicians. Insurance companies have for years been laying out the economic and market risks associated with climate change. Increasingly, companies themselves are taking a market hit for not dealing with it. CEOs are actually desperate for more guidance on consistent expectations on this front. For the Fed to ignore climate would be a breach of duty.

The same goes for cyber security, which Bloom Raskin looked at when she was deputy secretary of the Treasury, as well as cryptocurrency and digital coin. If this is “political”, then it is political around the world. Dozens of central banks are exploring or experimenting with digital currencies. Wider adoption of these represents an opportunity, but also a challenge, for regulators. This will be no less true over time for the dollar’s position as the global reserve currency, a risk that the Fed should be looking at closely.

The Fed should work closely with regulators such as the Securities and Exchange Commission, which have made cryptocurrency and cyber risk target issues, perhaps through the Financial Stability Oversight Council. This umbrella group brings together all US financial regulatory bodies to assess future risks. Bigger, broader conversations, in and outside the central bank, are crucial for detecting risk, which often falls in the seams between regulatory bodies, particularly now when we are undergoing such major technological, geopolitical and financial market shifts.

It’s also worth remembering that the Fed actually has a three-pronged job, which involves not just keeping inflation low and employment high, but also making communities more economically stable. That community mandate has received far less attention over many years than the details of trading rules or capital requirements. But it’s arguably more important, given the amount of speculative retail investing today.

One of the most worrisome things about the “everything bubble” brewed up by the Fed is that it has turned us all into speculators. It’s not only professionals but individuals who are buying into bitcoin and other highly speculative assets, using new online trading platforms and moving the market in ways that need much closer examination.

That’s why expanding the diversity of thought at the Fed, and the universe of risks being studied, is a great thing. As former Minneapolis Fed president Narayana Kocherlakota wrote recently, “Fed officials are too homogeneous, and too likely to empathise more with banks and investors than they do with the broader set of Americans whose wellbeing they are supposed to defend.” Biden’s new slate would help fix that, broadening perspective and risk management in the process. Here’s hoping it’s a smooth confirmation.



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