In my last post in this series, I observed that an economy's "base" money serves as the "raw material" that commercial banks and other private-market financial intermediaries employ in "producing" deposits of various kinds that can themselves serve as means of exchange.

If they could do so profitably, these private intermediaries would,  by making their substitutes more attractive than base money itself, collectively gain possession of every dollar of base money in existence. In some past monetary arrangements, most notably that of Scotland before 1845, banks came very close to achieving this ideal, thanks to the their freedom to supply their customers with circulating paper banknotes as well as with deposits, and to the fact that between them these two substitutes could serve every purpose coins might serve, and do so more conveniently than coins themselves.

All save a handful of commercial banks today are, in contrast, able to supply deposits only, so that only base money itself can serve as currency, that is, circulating money. The extent to which national money stocks have been "privatized," in the sense of being made up mainly of private IOUs of various kinds rather than officially-supplied base money, has been correspondingly limited, as has the extent to which private money holdings have served as a source of funding for bank loans.

When banks and other private-market intermediaries acquire base money, they do so, not for the sake of holding on to it, as they might were they mere warehouses, but in order to lend or otherwise invest it. More precisely, they do so in order to lend or invest most of the base money that comes their way, while keeping some on hand for the sake of either meeting their customers' requests for currency, or for settling accounts with other banks, as they must do at the end of each business day, if not more frequently. While banks' own substitutes for base money may serve in place of base money for all sorts of transactions among non-banks, those substitutes won't suffice for settling banks' dues to one another, for every bank is anxious to grab for itself as large a share of the market for money balances as possible, while contributing as little as possible to the shares possessed by rival banks.

Bankers have also learned, through hard experience, that by accumulating the IOUs of other banks, and thereby allowing other banks to accumulate their own IOUs in turn, they expose themselves to grave risks, which risks are best avoided by taking part in regular interbank settlements. Because even the most carefully-managed banks cannot perfectly control or predict the value of their net dues at the end of any particular settlement period, all would tend to equip themselves with a modest cushion of cash reserves even if they did not have to do so for the sake of stocking their ATM's or accommodating their customers' over-the-counter requests for cash.

Because banks typically receive fresh inflows of reserves every day, as a result of ordinary deposits, loan repayments, or maturing securities, a responsible banker, once having set-aside a reasonable cushion of reserves, has only to see to it that the lending and investment that his or her bank engages in just suffices to employ those inflows, in order to succeed in keeping it sufficiently liquid. Greater reserve inflows, if judged likely to be persistent, will inspire increased lending or investment, while reduced ones will have the opposite effect.* The bankers' general goal is to keep funds that come the bank's way profitably employed, while holding on to just so many reserves as are needed to accommodate fluctuations of net reserve drains around, and therefore often above, their long-run (zero) mean. More precisely, bankers' strive to keep reserves on hand sufficient to reduce the probability of losses exceeding available reserves to a (usually modest) level,  reflecting both the opportunity of holding reserves, which is to say the interest that might be earned on other assets, and the costs involved in making-up for reserve shortages, by borrowing from other banks or otherwise.

Throughout the history of banking, and despite laws that have suppressed commercial banknotes while often imposing minimum (but never maximum) reserve ratios on banks, bank reserves have generally constituted a very modest part of banks' total assets, and therefore a modest amount compared to their their total liabilities. Indeed, bank reserves have generally been but a small fraction of banks' readily redeemable or "demandable" liabilities. England's early"goldsmith" banks are supposed to have held reserves equal to only a third of their demandable liabilities -- a remarkably low figure, given the circumstances; at the other extreme, Scottish banks at the height of that nation's pre-1845 "free banking" episode often managed quite well with gold or silver reserves equal to between one and two percent of their outstanding notes and demand deposits. Modern banks, even prior to the recent crisis, have generally had to keep somewhat higher reserve ratios than their pre-1845 Scottish counterparts, mainly owing to the fact, mentioned above, that they must stock their cash machines and tills with base money, instead of being able to do so using their own circulating banknotes.

Between 1997 and 2005, for instance, U.S. depository institutions' reserves ranged, with rare exceptions,  between 11 and 14 percent of their demand deposits (see figure below). Put another way, for every dollar of base money "raw material" they acquired, U.S. commercial banks were able to "manufacture" (that is, to create and administer) just under 10 dollars of demand deposits.  That figure, the inverse of the banking system reserve ratio, is what's known as the reserve-deposit "multiplier."

The multiplier's significance to monetary policy is, or used to be, straightforward: it indicated the quantity of additional bank deposits that monetary authorities could expect to see banks produce in response to any increment of new bank reserves supplied them by means of either open-market operations or direct central bank loans. If, around 2000 (when the reserve-demand deposit multiplier was about 14), the Fed wanted to see bank's demand deposits increase by, say, $10 billion, it had only to see to it that they acquired $(10/14) billion in fresh reserves, which meant creating a somewhat larger quantity of new base dollars -- the difference serving to make up for the tendency of some of any newly created bank reserves to be converted into currency. The ratio of the total amount of new money, including both currency and bank deposits, generated in response to any new increment of base money, to that increment of base money itself, is known as the "base money multiplier."

Since the recent crisis, all sorts of nonsense has been written about the "death" of the reserve-deposit and base-money multipliers, and even (in some cases) about how we ought to be glad to say "good riddance" to them. I say "nonsense" because, first of all, the multipliers in question, being mere quotients arrived at using values that are themselves certainly very much alive, cannot themselves have "died," and because the working of these multipliers does not, as some authorities suppose, depend on the particular operating procedures central banks employ. Finally, although it's true that, until the recent crisis, economists were inclined, with good reason, to take the stability of the reserve-deposit and base-money multipliers for granted, it doesn't follow that they (or good ones, at least) ever regarded these values as constants, as opposed to variables the values of which depended on various determinants that are themselves capable of changing.

What certainly has happened since the crisis is, not that the reserve-deposit and base-money multipliers have died, but that their determinants have changed enough to cause them to plummet. U.S. bank reserves, for example, have (as seen in the next picture) gone from being equal to a bit more than a tenth of demand deposits to being about twice the value of such deposits!  The base-money (M2) multiplier, shown further below, has, at the same time, fallen to below half its pre-crisis level, from about 8 to 3.5 or so (not long ago it was less than 3).

These are remarkable changes, to be sure.  But they are hardly inexplicable. Banks' willingness to accumulate reserves depends, as I've already noted, on the cost of holding reserves, which itself depends on the interest yield of reserves compared to that of other assets banks might hold instead. Before the crisis, bank reserves earned no interest at all. On the other hand, banks had all sorts of ways in which to employ funds profitably, especially by lending to businesses both big and small. Consequently, banks held only modest reserves, and bank reserve and base-money multipliers were correspondingly large.

The crisis brought with it several changes that are more than capable of accounting for the multipliers' collapse.  The recession itself has, first of all, resulted in a general reduction in both nominal and real interest rates on loans and securities, to the point where some Treasury securities are now earning negative inflation-adjusted returns. Regulators have in turn responded to the crisis by cracking-down on all sorts of bank lending, making it costly, if not impossible, for banks, and smaller banks especially, to make many of the higher-return loans, including  small business loans, they would have been able to make, and to make profitably, before the crisis. (More here.) U.S. bank regulators have also begun to enforce Basel III's new "Liquidity Coverage Ratio" rules, compelling banks to increase the ratio of liquid assets, meaning reserves and Treasury securities, to less-liquid ones on their balance sheets. Finally, since October 2008, the Fed has been paying interest on bank reserves, at rates generally exceeding the yield on Treasury securities, thereby giving them reason to favor cash reserves over government securities for all their liquidity needs.

Whatever their cause, today's very low money multiplier values mean that commercial banks have ceased to contribute as they once did to the productive employment of scarce savings. Instead, those savings have been shunted to the Fed, and to other central banks, which use them to purchase government securities, and also for other purposes, but never, with rare exceptions (and with good reason), to fund potentially productive enterprises. Although discussions of monetary policy since the crisis have mainly had to do with the quantity of money, and central banks' efforts to expand that quantity so as to stimulate spending, the effects of the crisis, and of governments' response to it, on the quality of money, and especially on the investments its holders have been funding, deserve at least as much attention.

Continue Reading A Monetary Policy Primer:

• Part 1: Money
• Part 2: The Demand for Money
• Part 3: The Price Level
• Part 4: Stable Prices or Stable Spending?
• Part 5: The Supply of Money
• Part 6: The Reserve-Deposit Multiplier
• Part 7: Monetary Control, Then
• Part 8: Money in the Latest Great Muddle
• Part 9: Monetary Control, Now
• Part 10: Discretion, or a Rule?
• Part 11: Last-Resort Lending
• Part 12: Monetary Alternatives

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*Besides funding loans with retail deposits banks can and do fund them by borrowing on wholesale markets.  In that case, loans may be arranged in anticipation of a bank's acquisition of funds. Either way, banks must acquire base-money sufficient to finance their lending (that is, to cover their settlement dues) if they are to avoid having to rely too often on funding from last-minute interbank loans.

America’s Bank, Roger Lowenstein’s

2015 book on the founding of the Fed, is, as I said in reviewing it for Barron’s, both well-written and well-researched. Few pertinent details of the story appear to have escaped Lowenstein’s notice. However, in assembling and interpreting these details, Lowenstein appears not to have entertained the slightest doubt that the Federal Reserve Act, for all the political maneuvering that led to it, was the best of all possible means for ending this nation’s periodic financial crises.

Instead of turning a critical eye toward the 1913 Act, Lowenstein writes as if history itself were a reliable judge. What it has condemned he condemns as well; and what it has favored he favors. Consequently he treats all those persons who contributed to the Federal Reserve Act’s passage as right-thinking progressives, while regarding those who favored other solutions to the nation’s currency and banking ills as so many reactionary bumpkins.

That some strains of triumphalism should have found their way into Lowenstein’s account of the Fed’s origins is hardly surprising. Though research by economic historians and others supplies precious little support for it, the view that the Fed has been a smashing success is, after all, a well-established element of conventional wisdom, and one that Fed officials themselves never cease to promote. Nor have those officials ever devoted more effort to doing so than in the course of celebrating the Fed’s recent centennial. Even a much more hard-bitten journalist than Lowenstein could hardly have been expected to resist setting considerable store by an institution so universally (if undeservedly) hallowed.

Still, one might have expected a note of skepticism, if no more than that, to have found its way into America’s Bank. Lowenstein was, after all, writing about an institution that was supposed to end U.S. financial crises once and for all, and doing so in the wake of a crisis at least as bad, in many respects, as those that inspired its creation. (Those who suppose that the Fed did all it could and should have done to combat the recent cataclysm are encouraged to read this, this, this, and this.) He had, furthermore, encountered the many arguments — and most were far from being plainly idiotic — of pre-1913 experts who favored other reforms, as well as those of some of the pending Federal Reserve Act’s critics, who predicted, correctly, that it wouldn’t be long before its results would acutely disappoint those of its champions who sincerely yearned for financial and economic stability.

Perhaps most importantly, Lowenstein knew very well that Nelson (“Admit nothing. Explain nothing”) Aldrich, whom he (following Elmus Wicker) rightly regards as the man most responsible for clearing the way for the Fed’s establishment, was the outstanding crony capitalist politician in an epoch when such politicians were thicker on the ground than ever before or since. Although Aldrich presented the plan known by his name, much of which ended up being incorporated into the Federal Reserve Act, as a product of the collective efforts of the National Monetary Commission’s 16 members, the plan was actually one he himself drafted, with the help of several Wall Street bankers, in secret at Jekyll Island. The commission’s other members contributed nothing save their rubber stamp.

It’s wise to view Lowenstein’s assessment of Aldrich’s contribution in light of what other journalists have had to say about the long-serving Rhode Island Senator. Consider, for starters, Lincoln Steffens’ opinion, as expressed by him in a 1908 letter to Teddy Roosevelt. “What I really object to in him,” Steffens wrote, “is something he probably does honestly, out of general conviction. … He represents Wall Street; corrupt and corrupting business; men and Trusts that are forever seeking help, subsidies, privileges from government.”

Bad as this sounds, it’s nothing compared to the portrait muckraking journalist David Graham Phillips drew of Aldrich in The Treason of the Senate, his sulphurous 1906 exposé of an upper-house rife with corruption:

Various senators represent various divisions and subdivisions of this colossus. But Aldrich, rich through franchise grabbing, the intimate of Wall Street’s great robber barons, the father-in-law of the only son of the Rockefeller — Aldrich represents the colossus. Your first impression of many and conflicting interests has disappeared. You now see a single interest, with a single agent-in-chief to execute its single purpose — getting rich at the expense of the labor and the independence of the American people.

“Aldrich’s real work,” Phillips went on to write, consisted of “getting the wishes of his principals, directly or through their lawyers, and putting these wishes into proper form if they are orders for legislation or into the proper channels if they are orders to kill or emasculate legislation.” The work was “all done, of course, behind the scenes.” As chairman of the Senate Finance Committee Aldrich labored to “concoct and sugar-coat the bitter doses for the people — the loot measures and the suffocating of the measures in restraint of loot.”

Although the opinions of Steffens and Phillips might be dismissed as yellow journalism, the same cannot be said for similar verdicts reached by academic historians, including that of Jerome Sternstein, in his article “Corruption in the Gilded Age Senate: Nelson W. Aldrich and the Sugar Trust.” According to Sternstein, “far from insulating the legislative process from big business and reducing the incentives for corruption, the concentration of institutional authority in the hands of senators like Nelson W. Aldrich had precisely the opposite effect”:

Aldrich was wedded ardently to the concept that legislation affecting businessmen should be drawn up in close collaboration with businessmen. … America’s productive economy was not the work of politicians and theorists, but of innovative businessmen making business decisions in a most practical, efficient way. Members of Congress, therefore, had an obligation to clear appropriate legislation with them. Effective lawmaking, he held, especially that required to carry out the Republican gospel of prosperity and economic growth through vigorous state action in the form of protective tariffs and subsidies, was next to impossible otherwise. …

Thanks to his success in achieving the legislative goals of his corporate clients, Aldrich “found money and favors flowing to him. Businessmen did not bribe him, they did not dominate him — they simply rewarded and supported him.” In return for his efforts to shunt monetary reform onto a spur favoring the big Wall Street banks, for instance, Aldrich earned a token of gratitude from Henry P. Davison, a partner in J. P. Morgan & Company, who arranged and took part in the Jekyll Island meeting:

The enclosed [Davison wrote to Aldrich] refers to the stock of the Bankers Trust Company, of which you have been allotted one hundred shares. You will be called upon for payment of $40,000… It will be a pleasure for me to arrange this for you if you would like to have me do so.

I am particularly pleased to have you have this stock, as I believe it will give a good account of itself. I t is selling today on the basis of a little more than $500 a share. I hope, however, you will see fit to put it away, as it should improve with seasoning. Do not bother to read through the enclosed, unless you desire to do so. Just sign your name and return to me.

In view of Aldrich’s notoriety, Lowenstein might have suspected that, whatever its merits, the Aldrich Plan was bound to be compromised by its authors’ desire to look after Wall Street’s interests. He might therefore have entertained the possibility that neither it nor the Federal Reserve Act that drew so heavily from it was ideally suited to putting a stop to financial crises. But rather than proffer a revised (and not-so-triumphant) view of the Fed’s origins, Lowenstein elected instead to revise the record concerning Aldrich himself, turning him into his story’s unlikely hero. Just as some bolting horses supposedly turned Pascal into a religious mystic, the Panic of 1907 “jolted” Aldrich sufficiently, according to Lowenstein, to inspire his conversion, from Wall Street’s Man in Washington to high-minded proponent of monetary reform.

But did it? The facts suggest otherwise. Of the many shortcomings of the pre-Fed currency and banking system, none struck sincere reform proponents of all kinds as being in more dire need of correction than the tendency of the nation’s bank reserves to flow into the coffers of a handful of New York banks during seasons apart from the harvest, combined with the annual (and occasionally mad) harvest-time scramble for those same reserves. That ebb and flow of reserves from countryside to New York City and back again was the sine qua non of the crises that periodically rocked the U.S. economy. Unfortunately, that same ebb and flow was, so far as New York’s major banks themselves were concerned, good business, for it was the source of funds they lent on call to stock investors, by which they made a tidy profit. Any reform that might undermine their status as the ultimate custodians, for most of the year, of the nations’ bank reserves was, so far as they were concerned, anathema.

Until the Panic of 1907, Aldrich was able to satisfy his Wall Street clients simply by blocking — with the help of fellow standpatters — every monetary reform measure that came his committee’s way. The panic changed things, not by convincing Aldrich to clean up his act, but by forcing him to change his tactics. Realizing that reform could no longer be held off, he resolved to assume control of the reform movement, and to have it result in changes that, however sweeping, would nonetheless preserve, and even enhance, both the dangerous “pyramiding” of reserves in New York and his Wall Street chums’ bottom lines.

Just how Aldrich managed to achieve this goal — and to do so despite the rejection of his own plan in favor of a Democratic alternative — is a story too long to be told here. Interested readers will find it, and many other details besides, in my recent Cato Policy Analysis, “New York’s Bank: The National Monetary Commission and the Founding of the Fed,” which they can view by clicking on the image below. The information there will, I hope, allow them to conclude that, to gain a proper understanding of Aldrich’s part in the Fed’s establishment, one needn’t alter a single brushstroke in muckrakers’ portraits of him.

Since the financial crisis of 2007-09, and especially in recent months, Europe and the United States have seen zero and even slightly negative short-term nominal interest rates, and sub-zero risk-free real interest rates. In June I participated in a conference on “Zero Interest Rate Policy and Economic Order” at the University of Leipzig, organized by Gunther Schnabl (U Leipzig), Ansgar Belke (U Duisburg-Essen), and Thomas Mayer(Fossback von Storch Research Institute). The topic faced participants with the need to make a key judgment call: Are ultralow rates the new normal, i.e. are they long-run equilibrium rates determined by market fundamentals, or are they so low because of ultra-easy monetary policies and other policies? In Wicksell’s terminology, is the real “natural rate” currently below zero, or are central banks holding market rates below the current natural rate? We cannot directly observe the natural rate, but we can look for indirect indicators.

In Wicksell’s famous and now-standard analysis, a central bank can drive (or hold) the market rate of interest below the natural rate by injecting money, which shifts the supply of loanable funds curve to the right, increasing the quantity of loanable funds and lowering the interest rate (the “liquidity effect”). As the new money circulates it drives up prices and nominal incomes, however, which shifts the nominal demand for loanable funds curve to the right, raising the market interest rate (the “nominal income effect”). If the central bank wants to keep the market rate low in the face of the nominal income effect, it must accelerate the money injection. Short-term real rates have been negative, and nominal rates near zero, for eight years now with little sign of accelerating broad money growth or a rising inflation rate. Thus the Wicksellian cumulative-process scenario does not seem to be a viable candidate for explaining why current rates have remained so low since 2008.

Lukasz Rachel and Thomas D Smith, in a widely cited Bank of England working paper, spell out the market-fundamentals view: “The co-movement in rates across both advanced and emerging economies suggests a common driver: the global neutral real rate may have fallen.” They try to quantify changes over the last 30 years in the various factors shifting the supply of loanable funds rightward (population bulge nearing retirement, larger income share of the well-to-do, the “glut” of “precautionary saving by emerging markets”) and the demand leftward (depressed investment, higher risk premia) for loanable funds. Larry Summers, particularly in his Homer Jones lecture at the St. Louis Fed in April, has proposed that the demand for loanable funds curve has shifted leftward due to “secular stagnation.”

Several participants at the Leipzig conference offered an alternative view, particularly William R. White (formerly of the Bank for International Settlements, now at the OECD, and a member of the CMFA academic advisory board) and Andrew Filardo (BIS). Their view is spelled out in the new (unsigned) BIS Annual Report released on 26 June, just days after the conference. The Report argues that zero rates are not the permanent new normal, but are the lingering aftermath of the financial boom-bust cycle that developed economies have gone through. To quote (p. 14): “unchecked credit booms can be part of the problem and leave a long shadow after the bust, sapping productivity growth. In addition, debt overhangs depress investment, which weakens productivity further.” In a passage that bears quoting at length, the Report (p. 14) contrasts its view with the view that secular stagnation is the main force keeping interest rates low. The secular stagnation view fails to square with the fact that a credit boom preceded the bust:

[Our] interpretation of the post-crisis global growth slowdown differs in key respects from one that has been gaining currency – secular stagnation. It suggests rather that the world is better regarded as having suffered a series of financial booms gone wrong. Consider, admittedly in a very stylised form, the main differences in the two views. The most popular variant of the secular stagnation hypothesis posits that the world has been haunted by a structural deficiency in aggregate demand. This deficiency predates the crisis and is driven by a range of deep-seated factors, including population ageing, unequal income distribution and technological advances. In this view, the pre-crisis financial boom was the price to pay for having the economy run at potential. The key symptom of the malaise is the decline in real interest rates, short and long, which points to endemic disinflationary pressures. In the hypothesis proposed here, the world has been haunted by an inability to restrain financial booms that, once gone wrong, cause long-lasting damage. The outsize and unsustainable financial boom that preceded the crisis masked and exacerbated the decline in productivity growth. And rather than being the price to pay for satisfactory economic performance, the boom contributed, at least in part, to its deterioration, both directly and owing to the subsequent policy response.

The BIS, whose clients are the worlds’ central banks, does not directly blame central banks’ easy credit policies for fueling financial booms. But the reader is free to read the argument that way. When it comes to policy recommendations, the Report (p. 20) does call for tighter monetary policy (that is, tighter than inflation targeting suggests) to avoid feeding incipient booms: “monetary frameworks should allow for the possibility of tightening policy even if near-term inflation appears under control.” Rather than describe this as “using monetary policy to lean against financial imbalances” of unspecified origin as the Report does, I would characterize such an approach as using indicators other than only consumer prices (namely asset prices and/​or nominal GDP) as indicators to judge when monetary policy is too loose. Rather than describing the practical policy-making task as developing guidelines to help central banks “more effectively tackle the financial booms and busts,” I would say that we need guidelines to stop central banks from fueling financial booms and busts. Thus the BIS Report supports the case for nominal GDP as a less hazardous central bank target than the CPI or other inflation index, since an NGDP level target does not call for expansionary monetary policy to offset the benign price-lowering effects of productivity improvements.

The BIS Report deserves our serious attention. Its approach is more promising, to be sure, than the secular stagnation approach of Summers, who judges the last eight years of economic performance sub-par by reference to the extrapolated bubble path (aka the CBO’s 2007-estimated path of real potential output). His diagnosis: chronically insufficient nominal aggregate demand. This diagnosis implies that the price level has failed to approach its equilibrium level in the seven to eight years since the 2008-09 velocity shock, which violates our standard understanding about how long the price level takes to adjust to nominal shocks. It approaches incoherence to suppose that real interest rates have approximately reached long-run equilibrium in intertemporal markets, and simultaneously that the level of prices has not yet approximately reached long-run equilibrium in the spot market where money balances exchange against goods.

Global 10-year real government bond rates

Source: Summers (2015, p. 100)

[Cross-posted from Alt‑M.org]

In this post, I will stray a bit from monetary issues but not too far. The British people voted last Thursday (June 23^rd ) to exit the European Union. How should that decision be viewed by classical liberals? Do Americans have a stake in the outcome?

The political classes on both sides of the Atlantic are appalled at the voters’ decision. The peasants have risen up in revolt and their decision cannot be allowed to stand. There are already calls for a political mulligan in the form of a second referendum. Others have called for the British Parliament to nullify the vote. Both suggestions reveal the low regard for democratic decision making among Britain’s and Europe’s political elites. No one can predict the outcome at this point.

Let us pause for a moment and consider what the vote’s outcome says about the prescience of the ruling class in Britain, on the Continent and, yes, over here. (President Obama interjected himself into the vote and appeared dumbstruck last Friday when British voters rejected his advice.) Political leaders pretend to be wiser and better able to look into the future and discern what is best for the people. But almost to a person, they were unprepared for the referendum’s outcome. That speaks both to their distance from the people they claim to represent and their ability to forecast events even 24 hours in advance. So much for the wisdom of the elites.

(I am perplexed by just how surprised political and business leaders were. I was in Europe the weekend before and was briefed by a veteran British MP, who was firmly in the Remain camp. He called the election too close to call. He said that victory by the Leave side was entirely possible.)

What was at stake in the election? The leaders of the European Union portray it as promoting free trade and economic liberalism. It is far from that. The bureaucracy in Brussels has created an overbearing regulatory super-state, against which the British voters rose up. To classical liberals, since the demise of the Soviet Union, the European Union is the last bastion of central planning.

As is always true, there were multiple motivations to those wanting to breakaway. One group certainly felt that Britain could be more economically free out than in.

Immigration was an important issue there, as it has become here. Voters opposed an immigration policy imposed from afar. Additionally, Britain as an island had heretofore been largely immune from the mass migration from the Middle East, North Africa and elsewhere. It appeared that would no longer be true. Again, there is an echo in the United States in the debate over accepting Syrian refugees. Being emotion-laden, immigration can be the leading edge of popular discontent.

One thing not at stake in the election was the hoary issue of the currency. That issue had already been decided soon after the euro’s introduction as a currency on January 1, 1999. There was a move for Britain to adopt the euro, but it was strongly rebuffed. I am not usually an advocate of floating currencies. Faced with a monetary straightjacket of the euro, however, Britain wisely chose the flexibility of keeping the pound sterling. I helped make that case in Britain, and history has shown it to be a good decision. The pound was a monetary safety valve for Britain. But the political differences remained and eventually boiled over in this vote.

The core monetary issue is that no monetary policy could be the correct one for countries as economically diverse as those comprising the European Union (now numbering 28). The area did not meet the criteria of being an optimal currency area. Given those facts, Britain was better off conducting its own monetary policy.[1] There are now a total of nine countries within the EU that do not use the euro.[2]

Prime Minister Cameron was the architect of the referendum and, hence, his own demise. He advocated remaining in the EU but wanted to end the debate over the issue within the Conservative Party. He did not even consult his own Cabinet over the decision. For Cameron, it was a massive political blunder. He compounded that blunder by announcing his resignation, effective in October, at a news conference the day after the referendum. That rendered him the lamest of political ducks.

But the method by which the referendum got on the ballot put supporters of an EU exit at a profound disadvantage. They had no strategic economic plan in the event the referendum passed. That is why there is such extreme political and economic uncertainty. No one has exited the EU before. Neither the yet-undecided new British Prime Minister nor the EU leaders know what comes next. That is a situation of extreme economic uncertainty, which markets hate. We see this in the volatility in financial markets. Blame not British voters, however, but Cameron’s political stunt.

Fifteen years ago, two colleagues and I first proposed a global free trade association.[3] It would be a coalition of the willing, the most free-trading countries in the world. Some, but not all members of the EU would have qualified. That created the very problem now facing Britain: how can it trade more freely with the rest of the world and also trade preferentially with EU countries. The answer we eventually hit on was that Britain (and other qualifying EU members) could move from membership in the EU to membership in the broader European Economic Area (as Iceland, Liechtenstein and Norway are today).

The key point was that Britain would have had a plan and first have negotiated with the EU. Only then would it (and possibly other countries) have exited as members of the EU. Had it been done in that fashion, we would not be facing the global turmoil we are right now. It would have been Brexit with a plan.

We are where we are, however, and Britain’s new leadership must make the best of it. Assuming they honor the vote, they need to try to negotiate the best possible deal with the EU. It would be in Europe’s economic interests to negotiate the closest possible economic relationship. Financial markets have signaled that Continental European countries have more potentially to lose than does Britain. Some EU leaders have suggested, in effect, that Britain be punished for leaving. German Chancellor Merkel has called for calm and a sensible negotiating position. One hopes her good counsel prevails.

If the EU hotheads prevail, they will be cutting off their noses to spite their faces. As with all trade barriers, Britain’s “punishment” will inure to the harm of their own citizens as much as Britain’s.[4] I personally believe that Britain will prosper with or without a special relationship with the EU.

The divisions within the United Kingdom of England, Wales, Scotland and Northern Ireland were not created by the Brexit vote, but have been exacerbated by it. Scotland voted heavily to Remain, and Northern Ireland somewhat less heavily so. There is a move afoot for Scotland to hold a second referendum on its independence so it can join the EU on its own. I offer no opinion on whether Scotland will or should enter into disunion with the rest of the United Kingdom. If the union no longer benefits the British peoples, I wish them peace and prosperity as they chart their own courses. It would be difficult for an American of Irish heritage to say otherwise.

I conclude by answering my three questions. First, classical liberals should always applaud when a people chooses its own political future. This is especially so when they do so peacefully. Second, the United States has a special relationship with Britain, and it is in our interest to maintain that whether Britain is inside or outside the EU. Doing that may be complicated, and I only wish that the Obama administration had drawn up contingency plans for a Brexit vote. Finally, Britain’s choice to retain the pound is a test case for advocates of floating currencies. There are some problems they can address, but they are not a panacea.

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[1] The Bank of England always had the option to track the monetary policy of the European Central Bank. Some countries outside the euro effectively peg to it, which means they are importing ECB monetary policy.

[2] Besides the United Kingdom, they are Bulgaria, Croatia, the Czech Republic, Denmark, Hungary, Poland, Romania and Sweden.

[3] See Chapter 3, “The Free Trade Association: A Trade Agenda for the New Global Economy” by John C. Hulsman, Gerald P. O’Driscoll, Jr., and Denise H. Froning in 2001 Index of Economic Freedom, Gerald P. O’Driscoll, Jr., Kim R. Holmes and Melanie Kirkpatrick, eds.,(Washington, D.C. The Heritage Foundation and The Wall Street Journal, 2001): 43–62.

[4] One argument to punish Britain is to make it an example to others who might exit the EU. It is a curious position to take by those claiming the EU is a good deal for its members.

[Cross-posted from Alt‑M.org]

A surprising aspect of modern life in Africa is that, thanks to the telecom deregulations of the early 2000s, cell phones are as pervasive in its Sub-Saharan savannahs as they are in the urban jungles of the United States. More intriguingly still, African mobile network operators (MNOs) are leveraging their extensive networks to offer fast, reliable, and cheap mobile payment services to millions of customers beyond the reach of formal banks.

Kenya has been ground zero for this digital financial revolution. In 2007, the nation’s dominant cellular provider, Safaricom, launched M‑PESA. M‑PESA allowed users to send and receive digital payments anywhere in the country as simply as they send a text message. It also enabled customers to safely store money in their mobile wallet, pay for goods and services at virtually any retail shop, and deposit and withdraw cash from thousands of “agents” located across the country — all without ever stepping foot in a physical bank branch. Today, Kenya is one of the world’s leaders in mobile money with roughly 26.2 million accounts — more active accounts than adults in its population.

Why did mobile money first take off in Kenya? A variety of factors, such as its very high rates of theft and low rates of financial inclusion, helped create a latent demand for alternative financial services. However, the key to its success was its “enabling” regulatory environment. Unlike governments elsewhere, Kenya’s took a fairly “hands-off” approach, exempting innovative payments products offered by non-bank companies from many of the burdensome regulations that made it too costly for banks and traditional financial services providers to serve low-income customers.

In particular, MNOs like Safaricom were allowed to enter the market for payment services and issue digital claims that could circulate as money. They were also permitted to license part-time or full-time employees, or “agents,” to perform basic banking services (open new accounts, accept cash deposits and withdrawals, register customers, facilitate money transfers, etc.) on behalf of their customers.

Under this new “agent banking” model, MNOs were not only able to leverage their extensive networks of retail shops but also enlist other retail shops and upstart entrepreneurs to set up thousands of “mini-bank” branches throughout the country. Like Uber or Lyft drivers, these agents are independent contractors paid on commission. Since many agents operate out of small huts or as a side business at their existing retail shops, agent branches conduct business at a small fraction of the cost of traditional banks, making it a far more economical way to extend basic financial services to unbanked customers in remote regions.

At first, established banks weren’t happy about the Kenyan government issuing these regulatory exemptions. But once their lobbying efforts to ban M‑PESA failed to overcome the tidal wave of public support for the revolutionary product, many banks began partnering with Safaricom, establishing their own agent branches, and offering a fuller array of services to attract unbanked customers.

The most famous example is M‑Shwari, a partnership between the Commercial Bank of Kenya and Safaricom. Since its inception in 2013, more than 10 million Kenyans have gained access to interest-bearing mobile savings accounts (Cook & McKay, 2015). Customers also have access to mobile credit and insurance products. Since mobile providers can digitally collect and share information on how often customers pay their bills, which enables banks to construct reliable credit ratings, customers can apply for and receive up to $1,200 in loans (at 7.5 percent interest) with just a few clicks. Today, virtually every Kenyan commercial bank offers “branchless banking” services through a mobile money platform.

Thanks to these partnerships, the cell phone has become a catalyst for promoting financial development. Since the inception of M‑PESA, financial inclusion rates — that is, the percentage of Kenyans with any sort of access to formal financial institutions — have nearly tripled from fewer than 25 percent in 2006 to 67 percent in 2013 (GSMA, 2014). Kenya has also experienced increased financial deepening, defined as the ratio of private bank liabilities to GDP. The ratio rose from roughly 33 percent to 44 percent in the five years after M‑PESA (Ndirangu & Nyamongo, 2013, p. 3). The Economist Intelligence Unit projects that thanks in large part to mobile banking the amount of private bank credit and deposits will rise as much as 300–500 percent by 2020 (The Economist, 2011).

What lessons should economists draw from the mobile money revolution? For decades, many economists and policymakers assumed the private market would fail to profitably extend services to poor, unbanked customers. This is why many development officials in the postwar era have played an active, “hands-on” role in trying to engineer both financial and economic development. This government-led approach is what prevailed, incidentally, in Sub-Saharan Africa in the post-independence era. During the 1960s and 1970s, many newly established governments nationalized foreign-owned banks and used foreign aid to launch state-owned commercial banks. Unsurprisingly, these initiatives were an abject failure. Only 1 in 7 adults had access to a bank account before the advent of mobile money, giving Sub-Saharan Africa by far the lowest financial inclusion rate in the world.

The mobile money revolution provides a compelling example of a “market-led approach” to financial development. Based on Kenya’s success, the best thing governments can do to promote financial innovation and development is create a more enabling — that is, laissez-faire — regulatory environment, promoting what Mercatus’s Adam Thierer calls “permissionless innovation” and encouraging entrepreneurs to experiment with transformative new business models. Safaricom founder and CEO Michael Joseph aptly summarized this lesson:

I wouldn’t say the government needs to do anything. I would say the government just needs to have a “light touch” regulatory environment in order to encourage entrepreneurship and innovation.

Beyond mobile money and banking, the digital financial revolution also matters because it could help contribute to more rapid economic development. Economists from Adam Smith to Walter Bagehot to Joseph Schumpeter to more recent scholars like Rondo Cameron, Ronald McKinnon and Edward Shaw have argued that more developed private financial systems play a direct causal role in fostering economic growth and development.[1]

One reason the private financial system sparks more rapid growth is because the private sector can better allocate credit. The more people who hold their monetary wealth in the form of bank-issued liabilities such as mobile savings and checking accounts as opposed to government-issued currency, the more loanable funds they in effect provide to private financial intermediaries instead of governments and central bankers (Selgin & Lastrapes, 2012). These private banks can, in turn, intermediate these savings into productive loans in commercial investments. In fact, some authors have noted that Kenyans have reduced their demand for cash, opting instead to hold their savings in the form of mobile bank accounts. This, in turn, has been associated with a notable rise in loans to the private sector (Ndirangu & Nyamongo, 2013).

Today, mobile money is spreading like wildfire across the developing world. There are now 271 mobile money services available in 93 countries servicing more than 411 million customers (GSMA 2015). More than half of these services are connected to mobile banking accounts. The World Bank’s Global Financial Inclusion Database (2015) reports that mobile money is now available in 81 percent of low-income countries. Despite such rapid growth, the service has failed to gain traction in countries whose governments prohibit competitors from offering mobile money and strictly regulate agent banks. As the writers at The Economist (2012) aptly noted, “many of the poor countries that would most benefit from mobile money seemed intent on keeping its suppliers out — mainly by insisting they should be regulated like banks.” Due in large part to these repressive policies, mobile money has still only reached less than one-tenth of the unbanked population in the developing world.

Fortunately, a number of countries have begun emulating Kenya’s “hands-off” approach, arguably the strongest predictor of a successful mobile money launch. In fact, in countries that have adopted an enabling regulatory environment, active mobile money accounts are 220 percent higher (Di Castri, 2015). With a little insight from free banking theory, and practical experiences like Kenya’s, perhaps regulators could be encouraged to take their financial liberalization even further.

___________

[1] Over the past two decades, the “finance matters” theme has received an ample amount of empirical support in the development finance literature. See, for instance, the work of David Fry, Robert King, and Ross Levine, among others. Indeed, the link between a well-developed private banking system and the process of economic development has been stressed on this very blog here and here. These authors argue that developed financial systems help increase not only the total volume of loanable funds that banks have at their disposal to intermediate into productive investments, but also the marginal efficiency of investment and capital allocation.

(It occurred to us that some of our early posts, and especially ones from Alt‑M’s predecessor, Free​bank​ing​.org, may deserve a new airing, as they remain pertinent, but haven’t been seen by many of our newer readers. With that in mind, we’re pleased to introduce Friday FLASHBACKS: an occasional weekend dip into our archives. Enjoy!)

Skipping over ancient thinkers, early modern expressions of classical liberal thought on money may be found in the writings of Nicholas Oresme and other Scholastics who denounced the sovereign’s debasement of the coinage as a dishonest and tyrannical, a violation of the sanctity of contract that a just sovereign must respect. David Hume in the 1750s refuted the Mercantilist fear that unless the sovereign interfered with freedom of trade and payments the nation’s economy would retain too little silver and gold. Adam Smith in 1776, and later defenders of free banking in Britain, on the Continent, and in the Americas (my favorite being William Leggett), applied free-trade doctrines to banking and bank-issued currency. Thomas Hodgskin and Herbert Spencer even dared to defend private coinage. Walter Bagehot defended the principles of free banking, though he thought it a lost cause politically. In the twentieth century the Austrian economist Ludwig von Mises gave new subtlety and rigor to the case for free banking. Friedrich Hayek made somewhat ambivalent cases for gold and free banking earlier in his career, but in the 1970s forcefully called for Choice in Currency and The Denationalisation of Money. Free banking as a policy ideal is the result of applying the norms of classical liberalism to money and banking. Classical liberalism upholds individual liberty and private property rights, including freedom of contract, under the rule of law. It opposes rule by unconstrained authorities.

Many leading classical liberals over the centuries, however, have failed to apply their free-trade principles consistently to money. David Ricardo favored nationalization of coinage and banknote issue, and the forced substitution of redeemable paper notes for coins in all but the largest payments. Richard Cobden, the free trader, supported the nationalization of banknotes. After the Second World War, most of the German Ordoliberals and the Monetarists, led respectively by Walter Eucken and Milton Friedman, made peace with central banking and fiat money. (Although Friedman, it should be noted, reconsidered his position in the 1980s and began favoring free banking and the abolition of the central bank.) The otherwise radically free-market theorist Murray Rothbard favored a 100% reserve requirement, with no allowance for capitalist acts among mutually consenting adults who want to contract around that rule. Alternatives to fiat money, central banking, and deposit insurance were not on the program of the Mont Pelerin Society, a leading international society of classical liberal intellectuals, at its special meeting to discuss the financial crisis in 2009.

A century ago, before the First World War, economic classical liberals almost unanimously supported the ideals of the international gold standard. The “classical” period of the gold standard is usually dated from the United States’ resumption of gold payments in 1879 until the suspensions of payments in the First World War. The gold standard was fatally wounded in the First World War and never fully recovered. In practice it had not been a completely market-regulated system even before the war. National governments had long banned market competition in coining by giving themselves a monopoly in the minting of coins. Many similarly banned market competition in the issue of gold-backed banknotes and gave a monopoly to a government-sponsored central bank. National central banks violated the “rules of the game” by interfering with, overriding, or suspending the automatic operation of international gold flows. The centralization of gold reserves, a characteristic feature of central banking, altered the operation of the international gold standard for the worse.

Nonetheless the classical gold standard more nearly approached a self-regulating international monetary system than anything that has followed. Monetary nationalism and monetary statism since the First World War has brought us to our present system of national fiat monies, central banking, and extensive government interference in financial markets everywhere in the world (with the exception of offshore banking havens). The global financial crisis that began in 2007 has exposed the weakness and non-self-regulating character of the present system for all to see.

Our challenges for the present day, and for this blog, are to discover how we might reform the system in manner consistent with the ideals of freedom. How might we restore healthy self-regulation to our local and international monetary and banking systems?

Here are some references for the above history, which may also begin to answer Brad Jansen’s request for recommendations of classic readings.

Nicholas Oresme, De Moneta (Of Currency) [c. 1355], translated by Charles Johnson, in Lawrence H. White, ed., The History of Gold and Silver (London: Pickering and Chatto, 2000), vol. 1; David Hume, “Of the Balance of Trade,” in Essays, Moral, Political, and Literary, ed. Eugene F. Miller (Indianapolis: Liberty Fund, 1987); Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, ed. R. H. Campbell, A. S. Skinner, and W. B. Todd. (Oxford: Oxford University Press, 1976); Vera Smith, The Rationale of Central Banking [1936] (Indianapolis: Liberty Fund, 1990); William Leggett, Democratick Editorials (Indianapolis: Liberty Fund, 1984); Thomas Hodgskin, Popular Political Economy (London: Charles Tait, 1827); Herbert Spencer, “State-Tamperings with Money and Banks,” in Essays Scientific, Political and Speculative, vol. 3 (London: Williams and Norgate, 1891); Ludwig von Mises, The Theory of Money and Credit [1912] (Indianapolis: Liberty Fund, 1980); Mises, Human Action, 3^rd ed. (Chicago: Henry Regnery, 1966); F. A. Hayek, Choice in Currency (London: Institute of Economic Affairs, 1976); Hayek, Denationalisation of Money, 2^nd ed. (London: Institute of Economic Affairs, 1978). David Ricardo, Plan for the Establishment of a National Bank [1824] in The Works and Correspondence of David Ricardo, ed. Piero Sraffa with the Collaboration of M.H. Dobb (Indianapolis: Liberty Fund, 2005),vol. 4, Pamphlets and Papers 1815–1823; Richard Cobden in 1840 Parliamentary testimony cited by Lawrence H. White, Free Banking in Britain, 2^nd. ed (London: Institute of Economic Affairs, 1995), p. 84; Walter Eucken, Grundsätze der Wirtschaftspolitik (Tübingen: J. C. B. Mohr, 1952); Milton Friedman, A Program for Monetary Stability (New York: Fordham University Press, 1960); Friedman, “Monetary Policy for the 1980s” in John H. Moore, ed., To Promote Prosperity(Stanford: Hoover Institution Press, 1984); Murray N. Rothbard, “The Case for a 100 Percent Gold Dollar” in Leland Yeager, ed., In Search of a Monetary Constitution (Cambridge, MA: Harvard University Press, 1962).

[This article originally appeared at Free​bank​ing​.org, the predecessor site to Alt‑M.org, on June 4, 2011]

Federal Reserve Chair Janet Yellen recently appeared before the Senate Banking Committee to deliver the Semiannual Monetary Policy Report to the Congress. A handful of Senators queried Yellen as to the lack of diversity among both the Fed staff and the members of the Federal Open Market Committee (FOMC).

Here, for example, is the exchange between Senator Warren and Yellen (paraphrased, as I heard it):

Warren: Diversity is very important. Studies show gender diversity in leadership makes for stronger institutions. I’m not surprised there’s a stunning lack of diversity at our biggest financial institutions. The Fed’s leadership diversity is somewhat better, but not a whole lot better. … Does lack of diversity among regional Fed presidents concern you?

Yellen: Yes, I believe it’s important to have diverse groups of policy makers who can bring different perspectives to bear. It is the responsibility of regional banks’ Class B and C directors to to conduct a search and identify candidates for regional Fed presidents. The Board reviews those candidates and we insist the search be national and every attempt is made to identify a diverse pool of candidates.

Warren: But what about the outcome? When a new regional Fed president is selected by the regional Fed board that person must be approved by you and others on the Board of Governors before taking office. The Fed Board recently reappointed each and everyone of these presidents without any public debate or any public discussion about it. If you’re concerned about diversity, why didn’t you use these opportunities to say enough is enough? Let’s go back and see if we can find qualified regional presidents who also contribute to the overall diversity of the Fed’s leadership?

Yellen: Well we did undertake a thorough review of the reappointments … [etc., etc.]

Warren: [Interrupting] But you’re telling me diversity’s important and yet you just signed off on all these folks without any public discussion about it. …The selection process is broken. Congress should take a hard look at reforming the regional Fed selection process so that we can all benefit from a Fed leadership that reflects a broader array of backgrounds and interests.

While it is tempting to dismiss such questions as mere identity politics (I’m waiting for Trump to complain about bringing in the Fed Vice Chair from Israel), the Fed has increasingly over time come to look less and less like the rest of America.

Should this matter, at least in terms of monetary policy? I believe it should.

We are a big country and, despite a focus on national aggregates, different parts of the country experience different economic conditions. California isn’t Texas; nor is it Ohio or New York. To some extent these regional differences are why we have the convoluted regional structure of the FOMC. Different voices can bring their experiences and local knowledge to bear in a manner that should result in a monetary policy that weighs the conditions of both New York and Ohio (as well as the rest of the country). Researchers have found that local economic conditions do indeed influence voting behavior on the FOMC. The finding holds not just for the regional bank Presidents, but also for Fed governors.

Of course geography is only one element. Having Fed leadership from different segments of our society, as well as different disciplines, encourages multiple approaches to problem-solving. While I am an economist and see a lot of value in economics, I’d be the first to say economics doesn’t have all the answers. Similarly, bankers can have important insights into the functioning of the economy, but so can manufacturers, retailers and farmers.

A greater variety of backgrounds could also improve Fed communications. Spending a lot of time around economists, I think it is fair to say we often speak a different language, sometimes foreign and strange to outsiders. A Fed board where deliberations occur across disciplines could improve the explanations of those deliberations to the broader public. I know I’ve often learned a considerable amount of economics in the process of trying to explain something to non-economists.

It is perhaps for this reason that Section 10 of the Federal Reserve Act requires that

In selecting the members of the Board, not more than one of whom shall be selected from any one Federal Reserve district, the President shall have due regard to a fair representation of the financial, agricultural, industrial, and commercial interests, and geographical divisions of the country.

Despite the clear language of Section 10, since 1996 80 percent of Fed governors have come from the East Coast (which has only about 30 percent of the population). The chart below shows successful nominees and the Federal Reserve district they were connected with, as viewed by the President who nominated them, the Senate who approved them, and the district of the nominees birth. The fact is we are not getting a monetary policy reflecting the perspectives and needs of the entire nation, but rather one concentrating on those of New York and Washington (which falls in the Richmond district).

To some extent the heavy concentration of appointments to the Board from NY, Boston and DC reflects the revolving door between the Fed, the financial industry and the executive branch (particularly the Treasury and the Council of Economic Advisors). So the lack of diverse perspectives is likely even worse than it seems. Not only do Fed appointments reflect biases favoring New York, but predominately biases favoring New York’s financial industry. Similarly, for Washington, appointments reflect biases favoring the Treasury department or the status quo thinking in monetary economics.

As both The Wall Street Journal and the Harvard Business Review have noted, the FOMC has come to be dominated by academic economists. Josh Zumbrun observed in 2015:

Of the 17 Fed officials in office next year—five members of the Board of Governors and 12 regional bank presidents—all but three will have professional backgrounds as academics or with Goldman Sachs. The exceptions will be Atlanta Fed President Dennis Lockhart and Fed governor Jerome Powell, who worked at other banking institutions, and Kansas City Fed President Esther George, who was primarily a bank supervisor.

About 70 percent of Fed Board members and regional Presidents were once either Fed economists or academics:

Educational background of FOMC’s members has also become more concentrated around PhDs in economics:

Additionally, Fed economists themselves are heavily concentrated among the graduates of a handful of graduate programs:

Don’t get me wrong. A couple of smart economists with degrees from MIT, who have lived most of their lives in either Boston, New York or DC, are certainly able to contribute to monetary policy. But when the entire system starts to consist of individuals from the same small number of cities, who graduated from the same schools and studied the same disciplines, then “yes” we have a problem. You are guaranteed to have an institution that suffers deeply from groupthink, as well as being insulated from the everyday experiences of most Americans.

Senator Warren suggests that “the selection process is broken.” I couldn’t agree more. To repair it, we must first recognize that the choice of Fed Board members begins with the President. At a minimum the President should faithfully follow the considerations spelled out in Section 10 of the Federal Reserve Act. If he fails to do so, as was the case with the nomination of Peter Diamond, the Senate is obligated to reject that nomination. While Diamond’s case was clear, previous nominations have been less so. To provide some clarity, I would suggest that Congress amend Section 10 to list specific conditions determining residency. I believe a minimum of ten years actual residency should be the requirement for a nominee to be “from” a particular Fed district.

Congress could put additional limitations on Board appointments to increase diversity. For example, amending Section 10 to state that no more than two board members may come from any one of “finance, manufacturing, agriculture, government or academia” would reduce groupthink and likely increase the quality of decision-making at the Fed. Slowing the revolving door between the Fed, Treasury and finance could also increase diversity. I would suggest we ban from consideration for Fed nomination anyone who has served in the executive branch in the previous six years and impose a similar ban for those working for institutions regulated by the Fed.

Having worked on Fed nominations as a staffer for the Senate Banking Committee, I’d be the first to say that the Senate has too often rubber-stamped a President’s Fed nominees. Recent years have witnessed an improvement in Senate due diligence, but far more needs to be done. Changes in the norms behind Senate consideration may not be durable. Accordingly changes to the selection process for the FOMC are badly needed. I agree with Sen. Warren, the Fed needs leadership with a “broader array of backgrounds and interests.” Which means the definition of diversity must also include geographic diversity, educational diversity, and diversity of professional experience. The quality of monetary policy-making depends on it.

[Cross-posted from Alt‑M.org]