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Comment: There’s a difference between District Bank Presidents and the Chair of the Board of Directors

The probable nomination and potential confirmation of Herman Cain to a seat on the Federal Reserve Board of Governors could hinge on an understanding of his association with the Kansas City Federal Reserve. Some experience as an economist and/or staffer at a Federal Reserve District or at the Board is often helpful in promoting a candidate. However, it should be clear that Cain’s role at the Kansas City Fed was largely divorced from monetary policy.

The person who attends FOMC meetings and has a say in setting monetary policy and its framework is the President of that District. That person is also the CEO of that District.

Back in 1996, Cain was the Chair of the Kansas City Fed’s Board of Directors. Each District’s Board has an advisory role to the President of the respective District.

The Board of Governors publication about “The Roles and Responsibilities of Federal Reserve Directors” has this to say, “Reserve Bank head-office and Branch directors play a special role with respect to the formulation of monetary policy. Directors—with their diverse backgrounds, knowledge, and experience—report on economic developments in their respective regions and occupational sectors, as well as about other industries with which they might be familiar or possess insight. Directors also have an opportunity to express their views on appropriate monetary policy, including their assessment of the effectiveness of actual or prospective policy actions. In particular, every two weeks each Reserve Bank board provides the Board of Governors with a recommendation regarding the discount rates.”

The argument might be made that Cain in fact has had input on monetary policy because of the role in making recommendations on the discount rate. However, outside of times of crisis, the discount rate has served a mainly symbolic function for monetary policy in recent decades.

In January 2003, the discount rate was renamed and repurposed at the “primary credit rate” with a change to Regulation A. The announcement issued on October 31, 2002 said, “The rule replaces adjustment credit, which currently is extended at a below-market rate, with a new type of discount window credit called primary credit that will be broadly similar to credit programs offered by many other major central banks. Primary credit will be available for very short terms as a backup source of liquidity to depository institutions that are in generally sound financial condition in the judgment of the lending Federal Reserve Bank. The Board expects that most depository institutions will qualify for primary credit.” The nomenclature of “discount rate” has remained even after these alterations. The function and importance of the discount rate is different than in Cain’s time on the Kansas City Board of Directors.

The discount or primary credit rate is the rate charged to borrow from the Federal Reserve.  It is a short-term rate and the borrowing facility is little used except in times of need. Present levels are minuscule compared to the financial crisis and therefore do not exert a lot of influence in financial markets. In any case, each District’s Board’s recommendations go the Board of Governors which considers the requests from all 12 Banks and which is not obliged to act on them unless the Board of Governors sees a reason to do so. The Board rarely does so unless it is in conjunction with the full FOMC changing other short-term rates. The Board of Governors will generally only do this in a time of crisis when it wishes to signal that it will provide ample liquidity at lower rates to support financial institutions.

As to the advisory capacity about the regional economy to the President of the Kansas City Fed, I’ll reference the Fed’s Beige Book compilation of anecdotal evidence about the economy.

I think the Beige Book is one of the more important flags for turning points in the economy. Local business leaders are able to provide valuable insights on the ebbs and flows of economic conditions and whether these are short-term or more fundamental. However, the District Bank Boards don’t prepare the regional Beige Book report. They are part of the local business community and do represent another voice in how the President understands the regional economy. One can help validate the other. An ear to the ground among local businesses is vitally important, but no one person is likely to set the tone for how the District Bank perceives economic conditions.

If Cain is formally nominated to the Board of Governors — which President Trump has signaled he still plans to do — that nomination should be considered on its merits. It will be up to Senators to judge whether Cain’s past association with the Kansas City Fed is substantive among whatever other qualifications he presents.

 

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