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» COMMENTARY: WHITHER THE FED By Mark Lieberman, Chief Economist for the Five Star Institute What's up with the Federal Reserve? The venerable, usually media-shy central bank came in for more than its share of attention recently—and has no one to blame but itself. It started with the withdrawal of Larry Summers (whew) as a candidate to replace Chairman Ben Bernanke who, by the way, has not said he's leaving. Summers was as much a victim of selfinflicted wounds as he was of President Obama's decision to pass the buck and ask Congress for its approval of his plan to attack Syria to relieve the country of its chemical weapons. To be sure, the issues—attacking Syria and Summers' much discussed nomination—are themselves unrelated. With President Obama facing the prospect of a close (and possibly negative) vote on Syria, he could ill afford a close (and possibly negative) vote on a Summers' nomination. Now, of course, it appears there won't be a vote on either with a possible—albeit tentative—diplomatic solution on Syria and Summers' withdrawal. The Summers' candidacy exposed and exploited the Fed and its role in regulating the nation's economy in the abstract and major financial institutions specifically. Ironically, the Fed's responsibilities notwithstanding, the chairman is not entirely in charge. That role is played by the seven members of the Federal Reserve Board (the governors), who are supposed to have the experience and expertise—academic or otherwise—to understand the nation's complex economy. The Senate, in its wisdom, dithered over the 2010 nomination of Peter Diamond, who won the Nobel Prize in economic sciences but withdrew after Sen. Richard Shelby (R-Alabama) put a hold on his nomination. Shelby, whose academic career was confined to the University of Alabama (undergraduate and law school), is perhaps best known for his staunch opposition to the Troubled Asset Relief Program. Meanwhile, Diamond has degrees from Yale and the Massachusetts Institute of Technology and is the author of four books, including Saving Social Security. His expertise were good enough for the Nobel committee, but not for Sen. Shelby—but I digress. The opposition to Summers was not confined to Republicans. Liberal Democrats—in and out of the Senate—had concerns about his relevant experience as an architect of President Clinton's and then President Obama's economic policies and his position as president of Harvard. At Harvard, of course, Summers famously (or infa- mously) suggested innate differences in sex may explain why fewer women succeed in science and math careers. He cited research showing that more high school boys than girls tend to score at very high and very low levels on standardized math tests, adding it was important to consider the possibility that such differences may stem from biological differences between the sexes. In an effort to stem the furor over his remarks, Summers said later he was merely trying to provoke a discussion, but stood by his comments. If that weren't enough, questions were raised as well about some dubious—and costly—financial decisions during his Harvard presidency. During his tenure, the Board of Harvard Corporation, of which he was a member, entered into a series of interest rate swaps that ultimately (two years after he was pushed out as president in 2006) cost the school $1 billion: $497.6 million in termination fees paid to investment banks in 2008 and another $425 million to be paid over as many as 40 years. The investment decisions were made by Summers. Now that he has withdrawn, Fed Vice Chair Janet Yellen is seen as the frontrunner to replace Bernanke when his term as chairman expires at the end of January (an ironic twist, given Summers' gender comments). She would be the first woman to lead the Federal Reserve and would become one of the most powerful women in the world—probably not a reason to nominate her, but a credit nonetheless. One of the others mentioned as a possible successor to Bernanke is former Fed governor Roger Ferguson, who would be the first AfricanAmerican to chair the Federal Reserve. Also reportedly in the running: former Fed vice chair Donald Kohn and Stan Fischer, a former first deputy managing director of the International Monetary Fund and former governor of the Bank of Israel. The Federal Open Market Committee (FOMC)—made up of five of the 12 presidents of the Federal Reserve banks and the seven governors—concluded a two-day meeting in late September, defying expectations by making no change in its monetary stimulus program of holding the federal funds rate (the interest rate banks pay to borrow from each other) at 0-1/4 percent and continuing its purchase of $85 billion a month of mortgage-backed and Treasury securities. That the decision was unexpected is as much a surprise as the decision itself. Last December, the committee said in its post-meeting statement: VISIT US ONLINE @ DSNEWS.COM "In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longerrun goal, and longer-term inflation expectations continue to be well anchored." The formal projections made by the governors and all 12 bank presidents suggested the threshold would not be achieved for two years or more. To be sure, the Fed set the criteria only for raising interest rates and not for cutting back on its bond purchase program, so it could have acted to reduce that part of its stimulus and remain consistent with its own criteria. But when it set the numerical guides, the FOMC said it would "also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments." While on the surface those additional measures—specifically the unemployment rate—have been improving, a peek behind the curtain suggests otherwise. The unemployment rate, to be sure, has fallen to 7.3 percent from 7.8 percent, when the Fed announced its criteria. At the same time, though, the labor force has dropped, a factor that arithmetically would cause the unemployment rate to fall. Over the same period, the number of layoffs and discharges has fallen, as have initial claims for unemployment insurance, indicating the drop in the unemployment rate stems not for new hires but from fewer job cuts. St. Louis Fed President James Bullard told the New York Association for Business Economics at a recent luncheon the drop in the labor force was due to demographic factors dating back to 2000 (when immigration began to drop), suggesting the lack of new jobs was not to blame. For the Fed to have acted to scale back its quantitative easing program—to which it resorted when it could no longer cut rates—absent its own targets having been achieved would have damaged the bank's credibility, already strained from its failure to recognize the blossoming housing bubble and to act as the financial crisis was unfolding. After the Summers fiasco, that's the last thing the Fed needs. Hear more of Mark Lieberman's commentary on P.O.T.U.S. (Sirius-XM 124), Fridays at 6:20 a.m. (EDT). 47

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