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Fed needs collective wisdom, not charismatic leader

Monday, 5 Aug 2013 | 12:23 AM ET
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A much greater emphasis on mission and policies would be more useful than the current debate about personalities who might chair the U.S. Federal Reserve (Fed) after next January.

The difficulty of the Fed's mandate, the complexity of running the monetary policy in a country that drives the world economy and the crucial importance of guarding the institution's independence from political meddling would be best handled by a true college of equals rather than by a domineering leader.

The economics profession is well aware of the problems inherent in the Fed's charter. The task of simultaneously delivering undefined objectives of economic growth and price stability is feasible as a medium-term (a period of up to five years) target, provided that, during that time, there are no significant departures from these objectives induced by external (i.e., uncontrollable) shocks or major policy errors.

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Unfortunately, the general public is mostly uninformed about all this. The same is true of the political leaders, whose concerns – perhaps understandably – are tied to the electoral cycle rather than to time horizons over which the Fed can be reasonably expected to deliver advancing economy, rising jobs and stable prices.

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No solo players

The practical difficulty of finding and maintaining the appropriate monetary policy settings is almost naturally a task for a collective effort rather than for a charismatic, know-it-all leader whose views would be expected to dominate the rest of his/her colleagues.

The usual practice of identifying the Fed's work with the individual who happens to be in the chair is not only unfair to the rest of the members of the Fed's decision making body – the Federal Open Market Committee (FOMC) – but it also gives rise to virtually cultist traditions. Experience shows that this could lead to an overwhelming influence of a person who no longer considers himself as the first among equals.

In such cases, there is a danger that prudence commanded by facts and sound analysis could give way – as it did in recent times – to idiosyncratic views of politics and social order that can create serious problems for the economy and financial markets.

Only a strengthened collegial leadership, and a vigilant attention of informed financial media, could prevent this from happening.

The significance of such safeguards transcends inward-looking U.S. national interests. Indeed, the Fed is arguably the most important economic and financial institution in the world: it drives the global business cycle, sets the tone to world's financial markets and manages the world's key transactions and reserve currency.

And by influencing the economic fortunes of the world, the Fed also has a hand in how much benefit the U.S. will get from global trade and finance.

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This year, for example, the U.S. is expected to sell abroad $1.6 trillion worth of goods and services, and to import about $660 billion of foreign savings to finance its trade deficit.

The importance of all this is not lost on most thoughtful observers. I remember discussions in academic and international civil service settings about the need for direct policy inputs from major U.S. trading partners into the Fed's decision making. At times of soaring U.S. trade deficits and a weakening dollar, there were also tongue-in-cheek suggestions that some of America's largest foreign bond holders should have a seat on the FOMC.

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Collective wisdom

One can, of course, dismiss that, as did the former U.S. Treasury Secretary John Connolly in late 1971, when he told the meeting of the ten most important finance ministers in the world that "the dollar is our currency, but it is your problem."

The late John Connolly was well-known as a respected and charismatic political leader, but this message is an example of the harm such solo players can do. True, the dollar is the U.S. currency, but it is also true that the dollar is a de facto world currency, because it is an unmatched means of international payments and a principal store of value for official and privately held savings balances on a global scale.

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This episode is part of what is still known as the U.S. policy of dollar's "benign neglect."

But this not so benign idea of the drifting greenback became the core of the French-German determination to create the euro as an alternative to the dollar. That is still the unstated objective. Given that a quarter of world reserves is currently held in euros, and that the euro serves as a transactions currency and a legal tender in more than one-fifth of the world economy, it would be unwise to dismiss the European currency's challenge to dollar's supremacy.

It would be equally misguided to ignore the rising importance of the Chinese yuan. China continues to modernize its industry and financial markets, and, by some accounts, it is on the way of becoming the world's largest economy.

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The European terminology of the "defense of the dollar" is unnecessarily emphatic, but it does draw attention to the role the Fed's monetary policy should play to support American national interests in a world where nearly half of global trade is taking place in euro and yuan currency areas.

In this new game, the Fed needs all the collective wisdom of its highly-skilled technical staff, and of all of its FOMC members, to guide the U.S. economy and its financial system along a path of stable and sustained economic growth. That would be the best defense of the dollar and of U.S. global economic and political standing. And that should also be the only ideology driving the Fed's policy decisions. No charisma and quasi philosophers, please.

Michael Ivanovitch is president of MSI Global, a New York-based economic research company. He also served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York and taught economics at Columbia.

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