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Here's What Everyone Needs to Know about the Federal Reserve

Author Stephen H. Axilrod explains the three major changes in store for the Federal Reserve.

The following is an excerpt from the new book The Federal Reserve: What Everyone Needs to Know by Stephen H. Axilrod (Oxford University Press 2013): 

What major challenges face the Fed as an organization in the future?

Judged from today’s conditions, I would mention three. First, the Fed needs somehow to bring regulatory issues more to the fore in considering its monetary policy. It seems to be working in that direction. That will be greatly helped when the president actually nominates a governor to become vice chairman for supervision, the position added in the DFA. As earlier noted, the position has not yet been filled—left vacant since President Obama signed the DFA that created it into law in July 2010, about two and a half years ago from the time of this writing. While a governor can be designated by the chairman of the Board to perform the tasks, the position will evoke more authority and raise the profile of regulation within the Fed when held by a person who is sustained and perhaps even galvanized by the approval of both the President and the Senate for that particular task. Nonetheless, the Fed’s role and flexibility in better combining regulatory issues and monetary decisions will remain complicated by the wide dispersion of regulatory authority in the country—not to mention the long process still ahead for fully implementing the diverse provisions of the DFA, with the inevitable jockeying for bureaucratic authority and power that entails.

Fortunately, regulatory conditions and the overall stability of financial markets are likely to be seriously at cross-purposes with monetary policy rather infrequently. But when that hap- pens, markets can then be subject to disruptions and crises so far beyond the norm that they are politically and socially destabilizing for the country. Against that background, the challenge for the Fed is to assure itself more regularly and more intensely than has been its wont in the past about the stability of the macro-financial system.

That could well require, among other things, something like a regular Fed assessment of the macro-financial system similar to its regular semiannual report on macro-economic developments and monetary policy required by the Congress (in addition to its newly required biennial report on its own supervisory activities).

Second, it behooves the Fed to continue with its efforts to regain the institutional credibility with the public and the Congress that was severely shaken by the credit crisis. It had been thrown into so much doubt that even the Fed’s viabil- ity as an independent institution or, perhaps more practically, as an institution that could pursue its independent powers as effectively as desired seemed in question.

Some progress has been made to date I believe, but the institution’s credibility will again be tested once the eco- nomic after-effects attributable purely to the psychological damage from the crisis are behind us (they probably are by now). The FOMC will then have to begin making the very difficult decisions and choices implicit in its dual mandate for monetary policy. For instance, how much inflation will the nation need or tolerate for a potential economic recovery to be strong enough to revive the country’s sense of well-being? Or, if recovery falters much longer, how much more willing would the Fed and its principal officials feel about speaking even more plainly about the limits of monetary policy com- pared with other governmental policies in face of economic weakness?

If, or to be more historically accurate, when the economy once again becomes more cyclically volatile, the substance of the Fed’s more open communication policies—in general a plus to its credibility—might be in need of fine-tuning. There seems no doubt that the prompt announcements about the specifics of current policy have been and will remain impor- tant for policy implementation and credibility. But only time will tell whether indications of future policy intent and the quarterly forecasts of key economic developments will need further tinkering, in one way or another, if they are to help bolster the Fed’s reputation over the long run. However that may be, the Fed’s institutional stature will depend, as usual, almost wholly on how the economy performs and on how well inflation is contained.