Peter Conti-Brown on the Fed Trading Scandal, the Fed Chair Nomination Process, and Central Bank Governance

Peter Conti-Brown is a legal scholar and financial historian at the University of Pennsylvania and is a nonresident fellow in economic studies at the Brookings Institution. Peter’s scholarship focuses on the legal and historical issues of the Federal Reserve system, and he rejoins Macro Musings to talk about the many facets of Fed governance. David and Peter specifically discuss the Federal Reserve’s recent trading scandal, the Fed Chair nomination process, the central bank’s role in fighting climate change, and much more.

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: Peter, welcome back.

Peter Conti-Brown: Such a pleasure to be here, David. I think this is my fourth show. I'm nipping at the heels of George Selgin.

Beckworth: That's right. Watch out, George. Your title is on the line. That is for sure. Well Peter, I am excited to have you on because right now Fed governance issues are kind of front and central for us Fed watchers. A lot's going on: the trading scandal, nominations, I think even digital currencies are being influenced by this. So it's important to have a good conversation about Fed governance, and I can't think of anyone better than you Peter; to have you back on the show.

Beckworth: To get things going, before we get into the current events, I want to remind our listeners that you came on the show back in the simpler times of January 2020, so pre-pandemic. You came on. You had a paper out during that time titled *Restoring the Promise of Federal Reserve Governance.* It's a great paper. We'll provide a link to it, and go check out the show as well. But you made five points or five areas where the Fed really needs to improve and up its game. The first point you made in that paper was the lack of transparency surrounding this election and oversight of Federal Reserve Bank presidents, so the regional presidents. And we talked about, for example, John Williams. How did he get selected to the New York Fed? How did Neel Kashkari, Patrick Harker. A number of stories that just aren't very clear to the outsider, and your first point was that needs to be made more transparent, more accountable.

Beckworth: The second point you brought up was increased vacancies on the Board of Governors and a lack of public and presidential will to fill them. Third point or observation you made is there's a growing disparity between the salaries of reserve bank presidents and those of governors, which makes it harder to attract and retain qualified individuals to serve as governors. And you have some great charts, some original work, and they're showing the disparity, how over time they've really grown apart. What's probably the most striking number in there is the, if I recall correctly, the average salary of a regional bank president is like $400,000, and Chair Powell makes about $200,000. Is that right?

Conti-Brown: Yeah, ballpark. Right.

Beckworth: Yeah, so it's pretty striking. Fourth point, a majority of bank presidents being hired from within the Federal Reserve, which limits diversity in perspective and experience. So there's not a lot of outside talent flowing into the senior leadership positions, and finally governor nonparticipation in the FOMC meeting. So you had a nice chart and some data showing how the number of governors over time as a share of total voting blocks in the FOMC has declined.

Beckworth: So all of these speak to institutional problems that we talked about in that previous conversation, but I think this list can be expanded, it can be added to, Peter, after what we've seen these past few years. Even last year, the pandemic ... In fact, the previous show we were on we talked about the boundaries of the Fed and Treasury. Maybe we could add a discussion there as well to that list. But today I want to start with probably the most pressing topic, and this is the trading scandal, if we can call it that. And Peter, why don't you summarize it for our listeners? What has happened that really has lit the fire in terms of ethics concerns at the Federal Reserve?

The Fed Trading Scandal and Its Ethics Concerns

Conti-Brown: I think we can call this a scandal. I think that there's no other way to put what is happening at the Federal Reserve. It's a legitimacy crisis on the basis of some central bankers making some extraordinarily regrettable decisions about their private wealth.

I think we can call this a scandal. I think that there's no other way to put what is happening at the Federal Reserve. It's a legitimacy crisis on the basis of some central bankers making some extraordinarily regrettable decisions about their private wealth.

Conti-Brown: So the story got broken by Mike Derby at the Wall Street Journal, originally focused on Rob Kaplan, the president of the Federal Reserve bank of Dallas, you know former president. Looking through the financial disclosure which was available on request, it was not otherwise publicly available, Derby got the disclosure and looked through it and showed that there's a frenzy of trading going on for Kaplan in individual issuers. Meaning he's buying and selling stocks of companies, including those companies that are within the Federal Reserve district of Dallas. These aren't banks. He's forbidden from owning stock in banks, but these are companies of course the Federal Reserve has oversight, not just the banking system, but it is the primary economic regulator through monetary policy of the country.

Conti-Brown: But it's more than that. It's buying and trading around key dates when the Fed has been, in 2020, not just in its generic monetary policy capacity regulating the economy but in staving off financial and economic kind of crisis and calamity through its emergency lending programs. And so his proximity to both information that would tell you about the directions of asset prices and his active trading gives at the very least an appearance of conflict. It looks like he's using information of which he has privilege access and monetizing it for his own personal wealth. That's the appearance. He said, "Of course that's not what's happening. This has been approved by ethics officers on my general council of the Dallas Fed. This is not in violation of our rules." We can come back to that. I'm not so sure that's true, but that's where it starts.

Conti-Brown: Now it's very soon thereafter other journalists discovered that at least two other principals on the Federal Open Market Committee who've done things that look, I think, in decreasing severity but are still deeply problematic. So one is Eric Rosengren who's the former president of the Federal Reserve bank of Boston who had been buying and selling securities on mortgages, so real estate, in real estate investment trusts. Basically making bets on the direction of mortgage products. Which of course is a deep appearance of conflict given that the Federal Reserve, one of its tools in unconventional times has been the purchase of mortgage backed securities. So the same kind of appearance. And this, it looks like he's making a bet on interest rates while also participating in making policy about interest rates.

Conti-Brown: And the last one was a vice chair of the Fed; now it's a member of the Board of Governors, not a reserve bank president, Richard Clarida, looking like he did a major rebalancing selling bonds and buying stocks in index funds, not individual issuers. These are pretty broad based, but doing so at the bottom of the market, February 27th, the day before the Fed announces the beginning of what's turned out to be about a roughly eight week period of substantive news breaking every day, and you remember that period where it was just the Federal Reserve's on the front page of every newspaper as it was pushing from its 2008 playbook and expanding it pretty dramatically.

Conti-Brown: And at that moment, Clarida was mixing his portfolio in a way that has the appearance of taking advantage of that information. Because he's not selling stock and going into bonds. He's selling bonds and going into stock. And again, he said that that was a pre-scheduled portfolio rebalancing, but that even to me is deeply problematic. And so that's the scandal. The appearance that Federal Reserve policymakers, central bankers who hold this extraordinary public trust to guide so much of the economy, are enriching themselves for personal profit on the basis of that information, that public trust. That's the scandal.

The appearance that Federal Reserve policymakers, central bankers who hold this extraordinary public trust to guide so much of the economy, are enriching themselves for personal profit on the basis of that information, that public trust. That's the scandal.

Beckworth: So many questions this raises in my mind, but let me start with the first one. This is the thought that came to me, Peter, when I was first reading about this, and I thought to myself, "Even if this was approved, even if it was perfectly legal, what were you thinking?" You know, just the appearance of having some kind of inside track, just the appearance. When we are leaders in positions of responsibility and power, we are held to a higher standard and want to avoid the impression, and I think you would appreciate this point. I think this is especially important when we think of Fed independence, right? If the Fed wants to maintain its ability to make decisions based on facts and data, it doesn't want to open itself to this type of criticism, and we've seen Senator Elizabeth Warren really go after the Fed because of this. And it's understandable. People are concerned, this doesn't look great at all. I'm wondering, Peter, since you're both a historian of the Fed, you're also a lawyer, what legal issues are there, if any, in these actions?

The Legal Issues of Fed Trading

Conti-Brown: There are many legal issues here, and I'm with you 100%. I was talking to one Fed watcher who is extremely familiar with the way that the Fed works, and he said, quoting Casablanca, "I'm shocked, shocked to learn that this is happening inside the Fed," but David, I am legitimately shocked by this, non-ironically shocked. Because if one month ago you had asked me, "Hey, what do you think is the next ethics scandal to plague the Fed?" I would have said, "I don't think an ethics scandal will plague the Fed. The Fed’s legitimacy and policy issues and political issues are separate from that." One of the Fed’s great claims to fame is that it has been remarkably free of scandal. But so that's kind of my sense as a contemporary Fed watcher. Let me give you my sense as a lawyer and then as a historian.

David, I am legitimately shocked by this, non-ironically shocked. Because if one month ago you had asked me, 'Hey, what do you think is the next ethics scandal to plague the Fed?' I would have said, 'I don't think an ethics scandal will plague the Fed. The Fed’s legitimacy and policy issues and political issues are separate from that.'

Conti-Brown: A lot of people are saying, "Oh look, these were all legal trades. The rules are, the FOMC's rules governing trading during blackout periods, and so the rules were honored," and maybe that means the rules need to be changed. Jay Powell made this very point in congressional testimony. But I'll tell you, the rules required central bankers to avoid the appearance of conflict. Now that’s very standard. It's not specified further than that. If I were the lawyer consulted on this, I would say under no circumstances to Rob Kaplan or to Eric Rosengren or even to Rich Clarida are you to make this trade at this time. Because it is the very appearance of conflict.

Conti-Brown: And so even as a legal standard from the regulations that the FOMC and the Federal Reserve banks have issued, I think these trades ran afoul of it. Now there are other legal issues here. Senator Warren called on Chair Gensler of the Securities and Exchange Commission to investigate potential insider trading. I think that's a little bit of a stretch. I think I would be very surprised if the SEC decided to sue, initiate a civil action, against these folks on the basis of insider trading laws. But I do think that an investigation is warranted. I definitely think that.

Conti-Brown: Because there are ways that we could see the trades that have occurred, perhaps trades that we don't know about, that could implicate clear black letter securities law according to insider trading laws. Now there are also novel ways that we might apply insider trading law to capture some of these. I'm more skeptical of those. In other words, I think that there is legal risk that especially Kaplan but perhaps others have exposed themselves to. And that warrants an investigation. I think it's unlikely to result in any kind of referral to the Department of Justice or even a civil action of the SEC, but we’d  have to see what the investigation yields there.

Conti-Brown: So those are the legal ramifications. As a historian there are two minds on this. I said that the Fed has been remarkably scandal free. I'm not aware of anything close to this. You'll recall in a big part of the paper that I wrote for Mercatus about Jeffrey Lacker, the former president of the Richmond Fed, that was the biggest scandal we had seen in modern history of the Fed. Which was Lacker did not monetize information. He just shared it. He shared information in ways that he shouldn't have, and then arguably issued some misleading statements about whether he had or hadn't done that. And that was a huge scandal. That was a huge scandal. It resulted in his resignation. It was kind of a big deal. That is nothing compared to what we're dealing with right now. So I think that that's kind of what we're looking at.

Beckworth: Now, I was following you on Twitter. You got into a conversation with our friend Morgan Ricks about the Stock Act. Can you explain that? What was the discussion there? Does Morgan see some other angle to this?

Conti-Brown: Yeah. I can't tell if Morgan is stating his beliefs or if he was engaging in kind of an argument to kind of think through the issue. Although you'll have to ask him about that. But there are basically three general ideas that you can think of for insider trading. One is the classical theory which is an insider to a corporation with a security that's traded and is subject to securities laws either herself trades on that information or gives that information in exchange for a value. All right, that's classical insider trading. Right? That's not this, so far as we know. Again, I don't want to…

Beckworth: Right, right.

Conti-Brown: There's a second theory that this is a judicial interpretation. So this isn't anything Congress put into the law, but it's called misappropriation. That the misappropriation theory of insider trading. And that is that anyone who has a duty not to disclose information or not to monetize information who does so with material nonpublic information, that could still be insider trading. And so the theory there that Morgan was exploring with me on Twitter is they have, Kaplan and others, have a duty to the Fed to keep confidences on these material nonpublic information. They did not do so and traded on securities while in possession of material nonpublic information. And wouldn't that be in kind of an open shut easy application of misappropriation theory?

Conti-Brown: I don't think so. Because we've never seen any case law that goes this far. There are two elements of it that I think would be a stretch. One would be this particular category of information. I'm talking about just information about the actions of the Federal Reserve, a government agency. How it would apply to the entire economy. So that's new, and so I don't think the courts would stretch it that far. And then the second way that there would be a stretch comes in your question, "What is the Stock Act?" And that's the third mechanism you could think of for insider trading. That was passed in 2012, and it was trying to make clear that government employees are subject to insider trading laws, and it applies to all government employees in Congress, and the Judiciary, and in the Executive Branch. The Fed is in the Executive Branch for these purposes.

Conti-Brown: I don't think that that would necessarily apply either, especially to Kaplan and Rosengren, because they're not government employees. I wish that they were, as you know. I'm very skeptical of the idea that reserve banks are these private citizens. So I think they should be public employees, but I'm skeptical there. That said, that exchange with Morgan ... One of the great things about Twitter made clear to me, I think that are good arguments to be made that there's some insider trading smoke here that's worth the investigation.

I think that are good arguments to be made that there's some insider trading smoke here that's worth the investigation.

Beckworth: Okay, fair enough. So another question I had when reading this news and just processing it is, "Why now?" I mean, it just could be that Michael Derby for the first time decided to check this out, but this seems to be something that could have happened before this period at hand. So why do you think emerged now?

Conti-Brown: Yeah. It's a great question, and when I say that the Fed is remarkably scandal free, what if that's just because we have not learned about this stuff?

Beckworth: Right, right. Exactly.

Conti-Brown: A lot of this has actually been really common, and that would be great. That would be a terrific research project for Fed historians to investigate. See if we can find, if they still exist, any kind of trading activity from FOMC members of the years. I don't have a great answer for you, David. I think that, and I'm a little bit troubled by this aspect of it as well, and that is that it took journalists to find this and that the Fed didn't have a good handle on this as it was.

Conti-Brown: And I think the Fed’s answer to that, at least as we heard from Chair Powell, was, "Our rules are just out of date. They need to be rewritten." Your point earlier, David, I think is exactly right. I mean, what were they thinking? It can't be the case that any member of the Board of Governors who has oversight over the reserve bank presidents, if asked, "Is it good for us to have reserve bank presidents making directional bets on mortgage rates?" No, no.

Beckworth: It looks terrible.

Conti-Brown: It is inconceivable to me, inconceivable to me, that any member of the Board of Governors would say, "Oh yeah, that sounds like a good idea. That doesn't run afoul of our avoid the appearance of conflict." So I think that there's more to it than that. Another part of what I hope happens as the Fed investigates itself through the office of the inspector general, is that they think through a little bit better, “What is our oversight function? We're the Board of Governors of the Federal Reserve system. That means oversight not only over the, ‘Board of Governors,’ you know the Federal Reserve board in Washington, but over the entire system. Do we have the right oversight mechanisms in place not just to catch this after the scandal erupts but to make sure that the scandal doesn't get this far in the first place?” So I hope they revisit this. Because I think that this is a sign that some of that oversight was not as effective as it should have been.

Beckworth: Do you think Twitter played any role in this? So Michael Derby reports it first, but then it really caught on on Twitter, then Bloomberg, and other media organizations pursued these leads. No Twitter, would it be the same story, or would it have been a big story in any event?

Conti-Brown: I took a few months off Twitter this year for all kinds of reasons.

Beckworth: I've noticed.

Conti-Brown: Yeah, and I was struck by how much Twitter is not real life, David, as you well know. I don't know. I don't know. I will tell you that our corner of Twitter is really rather extraordinary. Fed Twitter and FinReg Twitter is very substantive. And this also confirms for me something that I've felt for a long time as a scholar and especially as a Fed historian. We are in a golden age of financial journalism where whipsmart and extremely capable journalists from across media outlets are just hungry, and they're hard working, and they they do really good work. So I think Twitter probably helps them in their work. That's been a way that I've connected with several of these journalists, just for an example, and I'd assume that that's the same for you.

Beckworth: Yep.

Conti-Brown: But I would say the real credit here goes to the journalists.

Beckworth: Journalists. Yeah, I'm going to have to get Michael Derby back on the show. He was on several years ago, and I [should] ask him, "What's the story behind the story here? What happened that led to this exploration of these documents?" So let's move to the solution. What do you think should be done?

The Solution in Dealing with the Fed Trading Scandal

Conti-Brown: Right. Number one is I think that there should be a very clear bright line rule, and that is that no central banker or frankly any Fed employee with access to FOMC deliberations can be an active market participant. By active, I mean taking open positions in anything other than index funds. So I don't think there should be any of the Kaplan trade [that] should simply be forbidden and prohibited. But I would go further than that. I would think that the Clarida trade, the rebalancing a portfolio, I think that any ... I would prefer to see central bankers buy structured products that rebalance by algorithm. So there's no human discretion involved. Rebalancing a portfolio when it's, "Oh, it's time to rebalance my portfolio. I'm going to do it tomorrow." That is not good. Then I think that should be forbidden. Because of the appearance of conflict. Like why was he rebalancing at the bottom of the market? That kind of thing.

I think that there should be a very clear bright line rule, and that is that no central banker or frankly any Fed employee with access to FOMC deliberations can be an active market participant.

Conti-Brown: So if they don't want to go that far, I think another version would be they have to file a disclosure with the Fed’s general council or the Board of Governors. I would love to see these done publicly. Which says the only time rebalancing will occur is the last day of every quarter. Just ironclad as a rule, there's no discretion, and the rebalancing will be in favor of this allocation. So it's announced ahead of time. And if you do that then ... If Clarida ends up his rebalancing was the day before the bottom of the market he would be like, "Look, a year ago I said I was going to go for a 60/40 stock bond allocation. It got backwards. So it was automatic." That to me is a full defense, and I would be fine with that. Again, I would rather see them not do any rebalancing. And I've heard some folks during the scandal say, "Oh, you're going to have a hard time recruiting people to be reserve bank presidents or members of the Board of Governors if you do that," and I just want to say if they only reason you want to be a central banker is that you can be an active trader in the market, we do not want people like that at the FOMC. Right?

Beckworth: Good point, good point.

Conti-Brown: [inaudible] …pick stocks and time markets, and god bless you if that's your passion. But not while you are carrying the public trust as a central banker.

Beckworth: No, great points, and I was hoping, Peter, you might speak also to the regional bank as an institution. I mean, does this add further fuel to your fire about the role and responsibility they have? Our friend Sam Bell's solution would be even more radical. He would say, "Either you get rid of the presidents or move them into the Board of Governors," but does this kind of reinforce the arguments you made in that previous paper we talked about?

Conti-Brown: You know my very first show with Macro Musings was in 2016 after my book came out on the power and independence of the Federal Reserve where I take a very critical look at whether the original public/private structure in 1913 as modified in 1935, whether it still made sense when central banking institutions the world over look nothing like this.

Conti-Brown: And I think that they don't. I think any justification for having "bankers" participate in our central banking policy are long gone. And so I'm not sure what the solution is there. I mean, what I offer in the paper is just have it so that we have much more clarity that the Board of Governors can hire or fire at will the reserve bank presidents. But Sam's idea is pretty good. I don't like the idea of having the reserve bank presidents be presidential appointments necessarily because I'm a little bit worried about the vacancy crisis spreading even further, and I also like the idea that we've got somebody sitting in Minneapolis and Cleveland and Philadelphia working day by day who then go to Washington to deliberate on monetary policy. I think that structure is pretty great.

Conti-Brown: But there should be no doubt that those are public employees. There should be no doubt that they carry the public trust. There should be no doubt that they're not answering to "shareholders" or a private board of directors consisting mostly of bankers. So I would scrub the Federal Reserve system of the stain of banker influence in that regard, even as we should try to preserve the ideological and intellectual diversity and other forms of diversity that the Federal Reserve system structure might introduce.

I would scrub the Federal Reserve system of the stain of banker influence...even as we should try to preserve the ideological and intellectual diversity and other forms of diversity that the Federal Reserve system structure might introduce.

Beckworth: Okay. Well, there's much more we could say about this, but we want to move on to some other Fed governance issues today. And the next topic I want to bring up is the Fed chair position. The nomination is coming up soon, and we think there are two main candidates: the current chair Jerome Powell and then Governor Lael Brainard. Any thoughts on this process?

Thoughts on the Fed Chair Nomination Process

Conti-Brown: Yeah, I love it. I think that the public debate involved in a Fed chair sweepstakes every four years is ... Some people really hate it. They talk about it, "Oh, this is like reality TV. This detracts from substance," and I'm not one of those folks. I think this is our opportunity to have big, powerful, important debates about what our values are, what matters. We're having that right now. Because the Democrats control the White House and Senate, the Republicans are pretty muted in their engagement on this, at least as far as I've seen.

Conti-Brown: But the intraparty fight on the Fed chair nomination is a fascinating and an important one. On the one hand you have folks who say, "Jay Powell has been a pretty legendary leader through 2020, through a monetary policy regime change which favors at least a longstanding democratic priority to place full employment at the center of the Fed’s monetary policy." And he resisted Donald Trump and all of these things. So he's great, should be reappointed.

I think this is our opportunity to have big, powerful, important debates about what our values are, what matters. We're having that right now...But the intraparty fight on the Fed chair nomination is a fascinating and an important one.

Conti-Brown: On the other hand we have folks who are pretty critical of Jay Powell, even before the ethics scandal, because he deferred to vice chair for supervision Randy Quarles and on a pretty deregulatory agenda over the last four years. So he was insufficiently aggressive in financial regulation. I just think that that debate is exactly the right one to have. What should we privilege more? Is the financial regulatory and bank supervisory role of the Fed chair in particular, is that more important? Are there tradeoffs? Do we lose something by having a nominal republican with great bipartisan credibility, in favor of someone who is more of our own and who's been more fiercely protective of the Fed’s regulatory priorities?

Conti-Brown: I love the debate. I think that it's really healthy, and some people get tired of it. But I think that this is the way that we do Fed accountability and governance so a round of applause all around. And I will tell you on the substance, these are two incredible central bankers. I think the United States is very lucky to be in a position where the two people we're considering are Jerome Powell and Lael Brainard. Deep experience, great variety of skills, very gifted central bankers. They understand the politics of central banking. They don't fall for that canard that this is an apolitical job. It's a deeply political job, and they bring different political skills to it. They're thinking about the future. They're thinking about legacy. So I think they're both terrific candidates. They have different strengths and weaknesses.

Conti-Brown: But one thing I do want to say connecting these two topics, the ethics scandal and this board appointment, this chair appointment sweepstakes … I don't think they're related. There are efforts right now to connect them, to say that Powell is disqualified because there's this ethics scandal that happened on his watch. I just don't buy that. I think that this ethics scandal, again, is incredibly huge and important to resolve well. But I think both Chair Powell and Governor Brainard are very well situated to take this on. I think they're very motivated to take this on. I think this offends their sense of what a central banker should be. And so I would trust either one of them to carry this investigation through. I don't see them as related. So folks are trying to connect them. I don't doubt their good faith, but I just ... It seems to me more motivated trying to take advantage of the political moment than anything else.

These are two incredible central bankers. I think the United States is very lucky to be in a position where the two people we're considering are Jerome Powell and Lael Brainard. Deep experience, great variety of skills, very gifted central bankers. They understand the politics of central banking.

Beckworth: Yeah. I think both of them should get a pass on this issue. I know it's easy to point fingers. Both of them, you could say, should have known better, should have had better oversight, but I think this is a separate issue in terms of the consideration for Fed chair role. So I agree. I think both of them would be good chairs. I think there's no doubt about that. But let me make the case for Powell without endorsing him. I'm not supposed to endorse anyone on my job. But let me make the case that I did in the New York Times piece I wrote about a month ago, and I want you to respond. I want you to push back, okay? Play the devil's advocate here if you don't mind.

Beckworth: The case I made for Jay Powell, and you touched on it, is his political capital. He is someone who can navigate the Fed, I think, through turbulent waters, through tough times, and we're going to talk about in a minute that the Fed’s existing new framework, you know how sure are we that it's going to last, and I think you need someone like Powell who can talk to both Republicans and Democrats. He can tell the Republicans, "Yeah, inflation's a little bit high now, but don't worry. We're going to see through it. Prices will be anchored in the long run." I also think that type of political capital is important if we get into issues of climate change at the Fed. You want someone who's viewed as a moderate who can push those through. So any thoughts, any pushback on that?

Pushing Back on Powell

Conti-Brown: It's hard. You're putting me in a position of devil's advocate when I think you're making some pretty compelling arguments. I think the pushback, again, is about democratic party priority since the Democrats are essentially deciding this question. And so that becomes a question of not, "Is it important for the Fed to be thinking about the relationship between climate change and monetary policy, and financial regulation, and bank supervision?" I don't think anyone really disputes that within the Democratic party, and I would say that many Republicans feel the same way. Very few, there are some, but very few would say, "The Fed should never say the words 'climate change,'" and I don't think that's a serious argument.

Conti-Brown: The question is, do you want someone who has a proven record of bipartisan political skills, deft bipartisan political skills, to manage what will have to be an incremental process of steering the Fed toward climate change solutions? Or, do you want someone who is an absolute expert and technocrat but came up through the Democratic Party, had significant positions of clear political positions, in Democratic administrations, the Obama Administration especially, who might be willing to go farther faster. I think that's the big debate.

Conti-Brown: That's a really big debate about your kind of ideology of what politics should be, going back generations. Right? Kind of a Burkean approach: move slow, don't break things; we've got a good thing going. Versus a much more radical one that says, "Yeah, we've got to break some stuff because we've got some existential crises looming." I don't see Jay Powell being someone who's going to throw out the playbook and say, "We're now a finance climate change agency." I honestly don't see Lael Brainard as doing that either, but she is, certainly, has a clear and obvious passion for thinking about the Fed’s bailiwick with respect to climate change and financial regulation. That we haven't seen from Jay Powell, especially in the last four years. So I think that's the big debate.

Beckworth: Yeah, and to be fair to Governor Brainard, I'm making the case of Powell based on what we do know about his political capital. Who's to say that she might demonstrate the same skills if given the chance, right? She might be able to establish good relationships with Republicans and Democrats. I just stress that it's important because there's a good chance Republicans win the House in 2022. And so you want to have someone who can work through that dynamic politically.

Beckworth: The other thing about the nomination process is it seems to be going on for a while, and maybe I've just forgotten how long these things last, but I'm wondering if there's complications in DC, other things that are taking the oxygen out of the room, that have prevented the name from being put out there. Because some of the stuff that's being said, some of the rhetoric, it is a good debate, but some of it I've seen get carried away. I just wish there were a name put out there, and then let's get the discussion going on that individual. But we have now the ethics scandal which complicates matters. We have, I think, this $3.5 trillion spending plan probably is taking attention away from it. Maybe even the Biden Administration says, "Look, the Fed’s working well enough," and a sense of urgency may not be there. What is your sense of what's happening in terms of timing?

The Timing of the Debate

Conti-Brown: Yeah, so many thoughts on that. I would give the Biden Administration extremely low marks on Fed governance so far. I cannot believe that we do not have a nominee for vice chair for supervision. That is stunning, and I don't think there's any good reason for it. There's so many good candidates. There's so many people who might fill that role. I recognize that the democratic coalition is fractured and that managing those fractures is hard work, but from a monetary policy perspective which President Biden has said that in these exact words that "full employment," is his number one priority. Well guess what? We have a whole agency of government, a system you might say, that has the legislative responsibility for full employment. And  I can't believe that there are Fed vacancies. That we don't have a vice chair for supervision. We don't have a short list for vice chair. So those, to me, are bigger errors. Historically now in the next week or two is the time when we would hear…

I would give the Biden Administration extremely low marks on Fed governance so far. I cannot believe that we do not have a nominee for vice chair for supervision. That is stunning, and I don't think there's any good reason for it.

Beckworth: Okay.

Conti-Brown: ... if not earlier, for Fed chair. And I think the fact that we've been having this robust debate about a shortlist is pretty healthy. So I'm not troubled by that. I'll agree with you that some of the rhetoric that people have brought opposed to the candidate, that is just not my political style, and I wince at that. I find that extremely regrettable. I think it turns allies into enemies, and I just, I don't see the point of that. But that said, I think that people really care about their conception of the central bank, and I don't fault them for that. And so I largely welcome the fierceness of the debate.

Beckworth: Yeah. Kind of as an aside, I've chuckled with some of our friends. What is it like inside the Eccles Building these past few months when the rhetoric has gotten so heated? I mean you know, Governor Brainard's office isn't that far from Chair Powell's office. So, what do they do when they walk by each other? I mean, there could be some…

Conti-Brown: I don't have any inside information on that, but by all press accounts, they're actually pretty good friends, and they're close colleagues... That's the other thing that's so baffling to me where you see one as an angel and one as a devil is they actually are kind of promoting the same vision of central banking right now. Take for example yesterday's speech by Governor Brainard, which I thought was very, very good about climate and climate scenario analysis. I mean, that's a co-authored product by Chair Powell and Governor Brainard and others. Right? This is not Governor Brainard saying, "I'm going rogue here." This is the Fed announcing where they're moving.

Conti-Brown: And so I don't see as much daylight between these two exceptional candidates as others do, and at the same time I do see the argument that we should ... that some within the Democratic Party want to prioritize much more aggressive financial regulation and want to take monetary policy off the front burner. If that's their argument or do both simultaneously, I get that. I'm not saying I share it, but I get that conception, and that is inspiring their approach to this debate.

Beckworth: Peter, let's go back to the vice chair for supervision just for a minute. You say you're shocked, you're surprised that there hasn't been any name suggested yet or proposed, nominated. Maybe for our listeners who don't know, tell us why it seems so shocking to you. Where are we right now, and why does it matter at this point in time?

Conti-Brown: Well, so the vice chair for supervision was a position created by Dodd Frank that went unfilled for seven years. Until Randy Quarles, the current vice chair for supervision, he's the only one who's ever held that Senate confirmed appointment. The vice chair is also a governor. So you have two roles simultaneously. One is on a 14 year term. The other is on a four year term. Now Daniel Tarullo is a governor on a 14 year term, and he had the portfolio of a vice chair for supervision without the appointment. And the Obama Administration was like, "Eh, he doesn't need the appointment. He's got the portfolio," and I think that was just completely wrong. I think that there would have been an authority that came with a Senate confirmation, the title, the priority that was a missed opportunity for the Obama Administration, and it seems to me that the Biden Administration ... I wonder if they're falling into that same trap. Because vice chair Quarles's appointment is ending this month. Now he's [inaudible] appointment as vice chair for supervision. His appointment as governor will continue, and he's not announced his intentions of what he'll do, whether he'll stay at the Fed or not.

Conti-Brown: And so I just think that this is something that should have been done over the summer. Do you know who I think would be an absolutely sensational vice chair for supervision is Lael Brainard, right? And I'm not the only one who thinks that. But right now the way they've structured it, which is just ... I'm gobsmacked by this. It will look like a consolation prize as opposed to the promotion and the emphatic vote of confidence and provision of financial regulation of bank supervision that it should be.

Do you know who I think would be an absolutely sensational vice chair for supervision is Lael Brainard, right? And I'm not the only one who thinks that. But right now the way they've structured it...I'm gobsmacked by this. It will look like a consolation prize as opposed to the promotion and the emphatic vote of confidence and provision of financial regulation of bank supervision that it should be.

Conti-Brown: I just think this is mismanaged. I think they should have announced vice chair for supervision months ago, well ahead of the chair, and then the chair debate could have occurred. If that had happened, if Lael Brainard had been nominated for vice chair for supervision, yeah she wouldn't be in the same discussion for Fed chair, but others would have been. The folks on the left who do not favor Jay Powell, they would have coalesced around a different candidate, and we would have been able to have a similar kind of debate. I would like to hear the counterargument from the administration. I just think this is mismanagement of the Fed governance.

Conti-Brown: And I haven't even mentioned that we're still waiting on nominees for Fed governor. There's a vacancy on the board, currently a vacancy on the board. Here, the Obama Administration did better, at least initially. President-elect Obama announced Dan Tarullo's appointment before inauguration. They should have done the same thing. And so I do fault them also for not naming and not filling that vacancy long ago.

Beckworth: Yeah, so the sense of urgency is that Randy Quarles's time as the vice chair for supervision is ending this month, and so someone has to fill it. If he stays on as governor, maybe he does a de facto ... I guess it depends on what the FOMC decides or the Board of Governors. Maybe Jay Powell decides. But the fact that they haven't means it's in limbo right now, and if ... This is your time. If you win the presidency, elections have consequences, and I think many people would have hoped in the Democratic Party that he would have made a choice by now.

Beckworth: Well let's move on to another governance issue, and that is the framework the Federal Reserve has adopted, and that is the flexible average inflation targeting framework. Do you have any worries that this framework might be in jeopardy given what's happened with inflation, with other developments on the ground? Going back to Chair Powell, will we have someone who can lead the Fed through a rough patch? If Republicans take power and question this framework, what is your sense of the direction?

The Direction of the Fed’s Current Framework

Conti-Brown: I think that we are in December 1980. That's the historical reference I would label. So we're about a year after Volcker announces a revolution in monetary policy. In October 1979 Volcker says, "We're going to completely change the way things are done. We're going to let interest rates find themselves. We're going to target quantities of money." And the question then became, "Well, how does that work? How is it going?" And interest rates skyrocketed. They stayed very high for a long time.

Conti-Brown: Targeting money, it turns out, was very hard to do well. They abandoned it a few years later but only after the experiment had runs its course delivering significant harm and scarring to the economy but also bringing inflation down. Right? And so right now we'll have the announcement of flexible average inflation targeting in August, which was signaled well in advance, is in its infancy, and it's facing its first major test which is inflation and the evidence of inflation and evidence of inflation that is much higher than was predicted and is higher still than is currently being predicted. So the Fed’s forecasts on inflation have not been great this year.

Conti-Brown: And so what does that mean for the framework? Well, again, the correlation is there. They announced the framework in August 2020. Inflation goes up thereafter, but I think the causal link of course is not that. This is the big debate in question. How permanent, how transitory, is this inflation? Is this more of a series of bottlenecks, the supply chain, the recovery from COVID, and that if we went ... And here I'm channeling my inner David Beckworth of course, and if we go the European route of 2011 and tighten fast, in other words abandon…

Beckworth: Yep.

Conti-Brown: ... the new framework. Is that the right approach? Because we need to win inflation now or whip inflation now, or do we need to give fate a chance? Now, there's not daylight between, so far as I can tell, between the two main candidates for Fed chair, but what there would be, I think, is how much political buy-in there will be to letting the experiment continue. And so I think ... And ironically enough of course, the question will be, will politicians push hard from a hawkish position? As opposed to trying to goose the Fed to do more, to be more dove-ish. Which again flips the usual narrative about the politics of central banking backwards.

Conti-Brown: And so I think ... I mean, that's my long answer to your short question. Your short question is, "Do you think that there's a question about the fate of fate?" And I think there is. I think it's extremely fragile. I think the Fed could abandon it. And for those who want to see the experiment run its way through, I think it's really important to think carefully about what the Fed should be doing in the face of these spikes in inflation: how it interprets it, how it understands it, what's its worldview for conceptualizing what they're facing, and what should be their reaction function in the face of it.

I think it's really important to think carefully about what the Fed should be doing in the face of these spikes in inflation: how it interprets it, how it understands it, what's its worldview for conceptualizing what they're facing, and what should be their reaction function in the face of it.

Beckworth: I like your clever play on words: the fate of fate. Or give fate a chance. Very ironic the way you phrase that. Let me just channel David Beckworth too since we're in this game right now. So what you said I completely, obviously agree with. We don't want to repeat the mistake of the ECB 2001, but I think the Fed and market pundits and observers can take comfort in this fact: yes inflation is higher than we thought it would be this year. Maybe it would be a little bit higher next year. Most consensus forecasts show it coming down the next year or the year after, and if that happens I think then the fate framework will be confirmed. It will be verified this is actually working.

Beckworth: But the fact I take comfort in now is if you look at inflation forecasts and look at inflation forecasts in particular at the five year, five year forward horizon. Which means in plain English if I take the average inflation rate over five years starting five years from now, it's anchored around 2%. If you take in some of these next five year, inflation forecasts, they are a little bit above 2%, but they've got this year, next year kind of embedded in them.

Beckworth: So if you look at a horizon that's beyond the supply shock horizon, we assume by that point supply shock disturbances are worked out, and at that far out we assume is simply macropolicy driving the inflation rate. It's anchored. So at least right now, and this is both from the bond market and from consensus forecasts, right now, the Fed is still credible. 2% long run is still credible. So to me, that says things are okay, and it also means most of the inflation is supply side driven. But I know I'm preaching to the choir here. I think I'm preaching to the choir here.

Conti-Brown: Well remember, I'm a Fed historian. I try not to wade too heavily into these debates, but I'll say this as a historian. And of course I have my ideology. I don't want to be coy. I find the fate framework to be very exciting. I think that my own, and I don't know if I've ever told you this David, but my own sense and part of my motivation in understanding the Fed is my father lost his job during the Volcker Recession, never worked again. He died a few years later, and I look at the ways that that reverberated. I'm one of seven kids. Our family, we still see that scarring. It shifted the trajectory. I'm doing great. That's not the issue there, but I think about this a lot. I think about how the Volcker shock affected cities like Gary, Indiana; Detroit; all these kinds of things. I think it's one of the most important things that we can think about as Fed historians is, what are the consequences of some of these experiments?

Conti-Brown: And so I find the patience to overshoot inflation targets to be very exciting, and the fragility of that commitment historically, this is something new under the sun. We've not seen this before, right, where a central bank is saying, "Not ... Let's run the printing presses." We've seen that lots of times. But saying, "Let's relax because what we have here is a model of the economy that says that we have been far too skittish in the past. So let us not be so in the future," and I think that's a different model. So in that sense you are preaching to the choir.

I think it's one of the most important things that we can think about as Fed historians is, what are the consequences of some of these experiments?

Conti-Brown: As a citizen, I'm pretty eager to see this experiment run itself through. As a Fed historian I just think that this is a such a departure from norm, and that makes it important. And I want to understand better, what are the motivations, especially for this new ideological faction which I would call the Hawkish Left? I think they're incredibly fascinating to me, people who are kind of end the Fed but from the left because they see the Fed’s easy money policy is creating problems of inequality or a variety of other arguments that they make. And I think that's a phenomenon that's really interesting. It's still a minority within the Democratic Party, so far as I can tell, but it's growing in its adherence. And so that's something I'll be watching pretty carefully.

Beckworth: I do think it is striking that the Federal Reserve was the first central bank to try this, too. I mean, it is unprecedented, but it's also unprecedented to have the most important central bank in the world try this experiment. Like inflation targeting in the 1990s was started by some smaller central banks. So we could sit back, watch them do it, and I know we've had conversations before… In fact, I think we were at a meeting, and you suggested that, "Why don't you have New Zealand or Australia try nominal GDP targeting first, and then if it works then we can sell it here in America?" You know?

Beckworth: But it's the other way around. We flipped it. The Fed is the first one to try some version of… it's a watered down version, but a version of level targeting. It kind of blows my mind away, right? And so now the ECB is dipping its toes in that pool too, maybe. I am surprised that the Fed has been so avant garde on this issue, and maybe again this has something to do with Jay Powell's leadership. He's able to navigate the Fed into something very bold, and maybe we don't recognize how bold it is until we have decades to look back upon it.

Beckworth: One question on this framework, and we'll move onto climate change. One thing I like about Rich Clarida, and I'm going to be disappointed to see him go, is he's been this intellectual force behind it, and he has provided probably the most details, at least his thinking on it. And that he called this something like a temporary price level target. Which goes back to Ben Bernanke, and if you read Ben Bernanke's original outline of what the temporary price level target looks like, Bernanke's very explicit. He says in this framework the Fed would not respond to inflation that's temporary, it's caused by supply shocks. So it can lead to some asymmetric response, and Clarida also highlights that in his two speeches he had on this where he laid out the details.

Beckworth: But if you go in and read the statement on longer run goals and monetary policy, they don't mention that. They do mention this importance of having an average 2% over the long run, and I think if Clarida could change it, he probably would put in there something along those lines. So I do think it's important to keep the momentum moving forward on this framework. There's unfinished business. You could see some other leadership coming into the FOMC, and reading this paragraph differently on their statement. Nothing is settled, right? We have to be mindful of where we are and what needs to be done.

Conti-Brown: Yeah. I wouldn't disagree.

Beckworth: Okay, let's move to climate change then. I'm going to give a quick rundown of what I've observed, Peter. So I had a previous guest on the show, and we talked about this a little bit, but in 2017 the Network for the Greening Financial System was established. It's a collaboration of central banks. The Fed joins it this year, finally. The Fed has two committees. It has the Supervision Climate Committee which is more of a microprudential focus, and it also now has a Financial Stability Climate Committee which is a macroprudential focus. They are already doing some things, but what more needs to be done, number one, and number two, what are the limits of what the Fed can do? You mentioned the Fed’s not going to be another EPA, but there are areas where it can focus and apply its energies in a productive manner.

What Can and Should the Fed Do to Help Fight Climate Change

Conti-Brown: Yeah. So I have a paper that I wrote with David Wishnick, a law professor at Georgetown, called *Technocratic Pragmatism, Bureaucratic Expertise, and the Federal Reserve,* and we're trying to map out what we should want from a Federal Reserve that is learning and experimenting. Because what we shouldn't want is the Federal Reserve to be the irregulator of everything under the sun. That presents some significant problems of democratic legitimacy and accountability. And people love to beat up on Congress, but man Congress is the center of it all. Right? So even the debates that we're having right now over the debt ceiling, a lot of people really hate that, mint the coin, skip all of this stuff. And you know, I haven't expressed any views on the legality of mint the coin or even its feasibility, but I sure do have a strong affection for the messiness of democratic deliberation.

Conti-Brown: And so I think there are limits to what the Fed can do. But these committees ... In this article with David Wishnick, we talk about where the Fed should have the most freedom of movement is in the research and deliberation side of its power. Where it should have the least freedom of movement is anything that's coercive and monopoly end of its spectrum. Because a coercion is a regulation where if you don't do this then you're going to have to do that, and monopoly is, of course, it's a provision of monetary policy which is, you know, unrivaled.

I think there are limits to what the Fed can do. But these committees...where the Fed should have the most freedom of movement is in the research and deliberation side of its power. Where it should have the least freedom of movement is anything that's coercive and monopoly end of its spectrum.

Conti-Brown: I'm more skeptical of the Fed moving very fast in very big ways that will make climate its central raison d'etre, but what the Fed has done so far is just terrific. So I think it should be doing more of this. Supervision is sort of in the middle of those things. And I think that it would be deeply problematic for the Fed to say, "Hey, politicians really disagree about climate change, and so we're going to be neutral by saying ... We're not going to address climate change and supervision." That's not neutral, right? That's playing a political game. That's taking the side of one side of a political argument, and I don't think the Fed should be doing that.

Conti-Brown: What it should be doing is saying, and that's what it is doing frankly, is to say, "We're watching this, and we're forming these committees in order to watch it more concretely. We're not just watching. We want to understand. We want to measure. We want to do research, and we want to see the ways that this existential crisis is going to intersect with the existing legislative mandates that we have." And there, I think that the Fed should have a lot of room to move around. And so that's where we see it. I think the Fed could do more probably and will do more as it learns more within this research and supervision side of things. As it learns more, I could see it passing regulation, notice and comment rulemaking for banks that reflect some of that learning. I think that would be clearly legal.

Conti-Brown: I would want it to tread more carefully there, but I wouldn't take that off the table. And where I'm getting more nervous is where you see some activists who want the Fed to use the monetary policy to change interest rates or create emergency facilities or ... and do things like that to address climate. For that, I say that sounds experimental, interesting, provocative. Let's have Congress design some institutions around this sort of set of issues, and let's let elections rise or fall on how Congress is going to handle that. So that's kind of where I would see climate. But I mean when I read Governor Brainard's speech yesterday on climate scenario analysis and the creation of these two committees which they already disclosed previously, I loved it. I thought it was exactly right. It's exactly what the Fed should be doing, this kind of scenario analysis, to understand the ways that its existing authorities intersect with the defining crisis of our time.

Beckworth: So it's a pragmatic step in the right direction, and we want to be careful though how many additional steps the Fed takes. Because I agree with you. If you want to, I think, fundamentally address climate change, you need Congress to do that. Maybe even establish a national investment authority. Something along those lines. We've talked about this before. This would be also useful during crisis when the Fed is asked to do a lot of the heavy lifting.

Beckworth: Let me push back just a little bit, Peter, on this legitimacy question. You alluded to this earlier, and I'm not sure this is the right breakdown, but let's say half the country voted for Trump, a little less than half, and then half voted for Biden. And Republicans and Democrats are divided on this climate change issue. Paul Tucker, as you know, has this book out on central banking, really some regulatory philosophy, and he makes this point for legitimacy and for any regulatory body, but we'll apply it to the central banks, where he says in order for Congress or Parliament in the UK to delegate authority to an agency, there needs to be sufficient consensus by the body politic on that issue.

Beckworth: So for example, most people agree price stability is a good thing. So they delegate that to the central bank. There's not much disagreement on that. Whereas on climate change you could argue it’s a very divisive issue in the country. Therefore, Congress should be doing more hands-on with it. Not a central bank like the Federal Reserve. If the Federal Reserve is getting its hands dirty in an area where it's very divisive, it's going to jeopardize its legitimacy when Republicans come to power next time. So how do you respond to Paul Tucker's argument?

Conti-Brown: I'm not persuaded by it. I just don't think it's correct. I don't think that ... The mechanism that we use to gauge consensus is called an election. And close elections or landslide elections are only different in the sense of the way the negotiation process goes through. What I don't like about Paul's framework is that it calls into question squeaker legislation that has passed with total legitimacy and legal authority of the US Constitution, but it just barely passes. Who cares? That's the law of the land, right? And you don't like it, you go run another election. And I think also it can fall into a very specific kind of historical error which is turning the past into a golden era that never was.

What I don't like about Paul's framework is that it calls into question squeaker legislation that has passed with total legitimacy and legal authority of the US Constitution, but it just barely passes. Who cares? That's the law of the land, right? And you don't like it, you go run another election.

Conti-Brown: You know, I'm writing, you called it before we started recording, my magnum opus, and I will accept that title. A big political history of the Federal Reserve. Oh my gosh, have we been fighting about this forever. We're just people yelling at each other in good faith and in bad faith, and sometimes that's reflected in very close votes, and sometimes it is not. But the point is, is that this idea that we can gauge consensus, I'm not even sure who would do it or what that would mean if it's something other than who won elections and who passed votes, whether it's by one vote or 100 votes in the House, or it's by one vote or ten votes in the Senate or whatever it is. I just don't see how that's relevant to anything.

Conti-Brown: And that might be true because it makes some of the enactments of winning coalitions more fragile. Then so be it. That's part of democracy is that the new folks get to undo the work of the past, and sometimes more of that sticks around than you would think. Let's take an example right now, right? If you had asked me, told me, in 2020 a democrat's going to win, and Janet Yellen's going to be the secretary of the Treasury, what do you expect would happen under a Yellen Treasury? I would have said, "Oh, we're going to see some heads knocking at FSOC. We're going to see some redesignations at the Financial Stability Oversight Council." We haven't seen that, David. Right? The Mnuchin FSOC kind of still is there in a sense. Not in personnel but in the work that they did, and so there's a lag around this kind of thing. Is that a good thing or a bad thing? I'm just saying that even on squeaker elections, policy changes can have an enduring logic. So, I think Paul Tucker is a terrific intellect and scholar, and I've read every page of his book, but…

Beckworth: It's a big book.

Conti-Brown: Yeah.

Beckworth: Yeah, and this is consistent with kind of the central theme of your writing is that I've seen what we've talked about in previous episodes, and that is the Fed is organic and changing. You've mentioned how the Fed today is very different than the original Fed that was created, and some of the relics of the Fed today have long been gone, as you mentioned earlier, and private banks being as part of a Federal Reserve system. So this is definitely consistent with your vision, and elections do have consequences. There's no way getting around that fact. Well with that, our time is up. Our guest today has been Peter Conti-Brown. Peter, thank you so much for coming back on the show.

Conti-Brown: Such a pleasure, David. Looking forward to my fifth visit in the future.

Beckworth: Will do.

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