A recent kerfluffle at the Minneapolis Fed is setting a new standard for the phrase “tempest in a teapot.”
Two high-ranking and brilliant economists have been eased out, prompting much buzz in the economics blogosphere and commentary in such publications as the Wall Street Journal, the Financial Times and from pundits such as Paul Krugman.
Whether or not these firings, together with the redefinition of the position of the director of research, are a bad idea is unclear.
Some prominent researchers, including at least two Nobel laureates (Krugman is one) have expressed opinions.
The intensity of this dispute coming only weeks before the centennial of the signing of the Federal Reserve Act, affords an opportunity to think about the roles of the 12 Fed districts banks and whether they are necessary.
First a bit of history: The Minneapolis Federal Reserve, where I worked as a low-level “regional economist” in the 1990s, always has been one of the smallest of the 12. Indeed, there was a question of whether it would get off the ground in 1914 since the act had specified a minimum collective level of assets of ordinary commercial banks willing to become members for it to become operational.
There were not enough such banks in the initially defined Ninth District and only with the expedient of shifting Michigan’s Upper Peninsula and a couple of dozen counties in northwest Wisconsin from the Chicago district to Minneapolis satisfied this legal requirement. This is where the district’s region stands now, stretching west from Lake Superior across the plains to include Montana.
Just as the smallest child in a large family has to act out to get noticed, the smallest districts in the Fed system need to do something distinctive to have an identity. St. Louis set itself up as a bastion of monetarism even as that school of thought was surpassed by new ideas. Kansas City specialized in agriculture, Chicago in futures and options markets, Dallas in U.S.-Mexican economic issues and so forth.
Minneapolis turned away from applied issues and made itself a center of cutting-edge macroeconomic theory by allying itself with the economics department of the University of Minnesota. At the time, the university had some of the most brilliant and innovative thinkers in the discipline.
This was the “rational expectations revolution” beginning in the 1970s that sought to sweep away the theories of John Maynard Keynes and his interpreters, which had dominated economics for 40 years. Minnesota had people like Tom Sargent, Neil Wallace and Christopher Sims. Edward Prescott came along later. All were faculty at the university. But they also had research positions at the Fed.
Robert Lucas was at the University of Chicago, but came up to the Minneapolis Fed frequently, including several summer-long stays. Four of these five eventually got Nobel Prizes and Neil Wallace, the exception, was cited in the awards to his colleagues.
The upshot was that a very small Fed bank ranked very high in tabulations of scholarly research papers by institution. And the prospect of joint university-Fed appointments made Minnesota an object of striving on the part of brilliant Ph.D. holders looking for their first positions. That helped the university in recruiting faculty in addition to raising the profile of the local Fed.
Moreover, it did not cost the Fed a lot of money. By paying bright researchers already at the university a moderate stipend and furnishing office space and research support, the Minneapolis Fed got a higher profile within the overall Fed system and within economics. It also gave the Fed a permanent staff an opportunity to interact with some of the brightest minds of the day.
That’s fine for the status of the institution and of some benefit to the quality of other research done there. But what did it do for society as a whole?
Skeptics argue that the whole process was analogous to some minor small-appliance manufacturer paying Black and Decker for the right to place its name on their toasters. Did society really get a lot more productive research? Or was credit for research that would have been done anyway just spread across more institutions?
Most importantly, did this arrangement improve the quality of monetary policy decided on by the Fed as a whole or even the modest input of one small district into that national policy?
Bringing us to today, that is the question raised by the firing earlier this month of the two key researchers. One, Ellen McGrattan, was a full-time staff researcher at the Fed who had just gotten a faculty position offer from the university. The other, Patrick Kehoe, was a university professor with an additional appointment at the Fed. Both are brilliant and productive economists, big names in the discipline.
But they certainly differ from the current policy views of Narayana Kocherlakota, the Minneapolis Fed president since 2009, and there may be some personality differences as well. All three individuals are part of the continued relationship between the university and the Fed.
From the time Kocherlakota first came to the University of Minnesota in 1998 until after his assuming the Minneapolis Fed presidency in 2009, he was thought clearly in the camp of the anti-Keynesian cohort in his department and at the Fed.
Indeed, his stance against the loose-money policy of Fed Chariman Ben Bernanke was clear in his speeches after taking over at the Fed and in his votes and statements in 2011, his first turn as a voting member of the policy-making Federal Open Market Committee.
But somewhere along the way, Kocherlakota had a road-to-Damascus conversion in his policy outlook and now is an articulate supporter of low interest rates via quantitative easing over an extended period. King Lear’s plaint, “How sharper than a serpent’s tooth it is to have a thankless child,” probably ran through the mind of at least some of the intellectual colleagues he abandoned.
Champions of Kehoe and McGrattan, including Nobelist Prescott, who long occupied a similar position at the Minneapolis Fed as the two, argue that their leaving represents an intolerant quashing of dissenting views that will hurt the quality of policy making.
I am one of many skeptics. Kocherlakota will still have access to all of the newest research that may bear on monetary policy. As a speaker promulgating his views, he will be one of only 12 district bank presidents and seven governors who participate in open market meetings. And he will be only one of 12 votes, and that only every third year.
Trying to follow what happened at the bank is sort of like watching cats in a gunny sack. There is some yelping and jumping around, but it is hard to tell who did what to whom. Egos may be bruised, but our republic will survive.
More broadly, the Fed was set up with 12 districts and over 30 additional branches in response to the politics of 1913 and the needs of operating a payments system in the days of steam locomotives. Things have changed.
Advocates of the status quo argue that the existing system funnels input from the grassroots level via 12 nine-member local boards of directors who confer with district bank presidents twice monthly. These presidents in turn all participate in FOMC meetings. I think this is correct, but whether this small improvement in policymaking is worth the cost of maintaining a century old system is debatable. And the influence of even the most esteemed economic researcher at any district bank is infinitesimal.