Yes, the Federal Reserve has a Diversity Problem

Board of Governors, diversity, Elizabeth Warren, FOMC, Janet Yellen
Library of Congress photo: "Federal Reserve Board with Bankers. Front: Warburg, Williams, Hamlin, Delano. In rear is large group of governors and bankers."

Federal Reserve White MenFederal Reserve Chair Janet Yellen recently appeared before the Senate Banking Committee to deliver the Semiannual Monetary Policy Report to the Congress.  A handful of Senators queried Yellen as to the lack of diversity among both the Fed staff and the members of the Federal Open Market Committee (FOMC).

Here, for example, is the exchange between Senator Warren and Yellen (paraphrased, as I heard it):

Warren: Diversity is very important.  Studies show gender diversity in leadership makes for stronger institutions.  I’m not surprised there’s a stunning lack of diversity at our biggest financial institutions.  The Fed’s leadership diversity is somewhat better, but not a whole lot better. … Does lack of diversity among regional Fed presidents concern you?

Yellen: Yes, I believe it’s important to have diverse groups of policy makers who can bring different perspectives to bear.  It is the responsibility of regional banks’ Class B and C directors to to conduct a search and identify candidates for regional Fed presidents.  The Board reviews those candidates and we insist the search be national and every attempt is made to identify a diverse pool of candidates.

Warren: But what about the outcome?  When a new regional Fed president is selected by the regional Fed board that person must be approved by you and others on the Board of Governors before taking office.  The Fed Board recently reappointed each and everyone of these presidents without any public debate or any public discussion about it.  If you’re concerned about diversity, why didn’t you use these opportunities to say enough is enough?  Let’s go back and see if we can find qualified regional presidents who also contribute to the overall diversity of the Fed’s leadership?

Yellen: Well we did undertake a thorough review of the reappointments … [etc., etc.]

Warren: [Interrupting] But you’re telling me diversity’s important and yet you just signed off on all these folks without any public discussion about it. … The selection process is broken. Congress should take a hard look at reforming the regional Fed selection process so that we can all benefit from a Fed leadership that reflects a broader array of backgrounds and interests.

While it is tempting to dismiss such questions as mere identity politics (I’m waiting for Trump to complain about bringing in the Fed Vice Chair from Israel), the Fed has increasingly over time come to look less and less like the rest of America.

Should this matter, at least in terms of monetary policy?  I believe it should.  We are a big country and, despite a focus on national aggregates, different parts of the country experience different economic conditions.  California isn’t Texas; nor is it Ohio or New York.  To some extent these regional differences are why we have the convoluted regional structure of the FOMC.  Different voices can bring their experiences and local knowledge to bear in a manner that should result in a monetary policy that weighs the conditions of both New York and Ohio (as well as the rest of the country).  Researchers have found that local economic conditions do indeed influence voting behavior on the FOMC.  The finding holds not just for the regional bank Presidents, but also for Fed governors.

Of course geography is only one element.  Having Fed leadership from different segments of our society, as well as different disciplines, encourages multiple approaches to problem-solving.  While I am an economist and see a lot of value in economics, I’d be the first to say economics doesn’t have all the answers.  Similarly, bankers can have important insights into the functioning of the economy, but so can manufacturers, retailers and farmers.

A greater variety of backgrounds could also improve Fed communications.  Spending a lot of time around economists, I think it is fair to say we often speak a different language, sometimes foreign and strange to outsiders.  A Fed board where deliberations occur across disciplines could improve the explanations of those deliberations to the broader public.  I know I’ve often learned a considerable amount of economics in the process of trying to explain something to non-economists.

It is perhaps for this reason that Section 10 of the Federal Reserve Act requires that

In selecting the members of the Board, not more than one of whom shall be selected from any one Federal Reserve district, the President shall have due regard to a fair representation of the financial, agricultural, industrial, and commercial interests, and geographical divisions of the country.

Despite the clear language of Section 10, since 1996 80 percent of Fed governors have come from the East Coast (which has only about 30 percent of the population).  The chart below shows successful nominees and the Federal Reserve district they were connected with, as viewed by the President who nominated them, the Senate who approved them, and the district of the nominees birth.  The fact is we are not getting a monetary policy reflecting the perspectives and needs of the entire nation, but rather one concentrating on those of New York and Washington (which falls in the Richmond district).

Calabria 1 Cropped

To some extent the heavy concentration of appointments to the Board from NY, Boston and DC reflects the revolving door between the Fed, the financial industry and the executive branch (particularly the Treasury and the Council of Economic Advisors).  So the lack of diverse perspectives is likely even worse than it seems.  Not only do Fed appointments reflect biases favoring New York, but predominately biases favoring New York’s financial industry.  Similarly, for Washington, appointments reflect biases favoring the Treasury department or the status quo thinking in monetary economics.

As both The Wall Street Journal and the Harvard Business Review have noted, the FOMC has come to be dominated by academic economists.  Josh Zumbrun observed in 2015:

Of the 17 Fed officials in office next year—five members of the Board of Governors and 12 regional bank presidents—all but three will have professional backgrounds as academics or with Goldman Sachs.  The exceptions will be Atlanta Fed President Dennis Lockhart and Fed governor Jerome Powell, who worked at other banking institutions, and Kansas City Fed President Esther George, who was primarily a bank supervisor.

About 70 percent of Fed Board members and regional Presidents were once either Fed economists or academics:

Calabria 2

Educational background of FOMC’s members has also become more concentrated around PhDs in economics:

Calabria 3

Additionally, Fed economists themselves are heavily concentrated among the graduates of a handful of graduate programs:

Calabria 4

Don’t get me wrong.  A couple of smart economists with degrees from MIT, who have lived most of their lives in either Boston, New York or DC, are certainly able to contribute to monetary policy.  But when the entire system starts to consist of individuals from the same small number of cities, who graduated from the same schools and studied the same disciplines, then “yes” we have a problem.  You are guaranteed to have an institution that suffers deeply from groupthink, as well as being insulated from the everyday experiences of most Americans.

Senator Warren suggests that “the selection process is broken.”  I couldn’t agree more.  To repair it, we must first recognize that the choice of Fed Board members begins with the President.  At a minimum the President should faithfully follow the considerations spelled out in Section 10 of the Federal Reserve Act.  If he fails to do so, as was the case with the nomination of Peter Diamond, the Senate is obligated to reject that nomination.  While Diamond’s case was clear, previous nominations have been less so.  To provide some clarity, I would suggest that Congress amend Section 10 to list specific conditions determining residency.  I believe a minimum of ten years actual residency should be the requirement for a nominee to be “from” a particular Fed district.

Congress could put additional limitations on Board appointments to increase diversity.  For example, amending Section 10 to state that no more than two board members may come from any one of “finance, manufacturing, agriculture, government or academia” would reduce groupthink and likely increase the quality of decision-making at the Fed.  Slowing the revolving door between the Fed, Treasury and finance could also increase diversity.  I would suggest we ban from consideration for Fed nomination anyone who has served in the executive branch in the previous six years and impose a similar ban for those working for institutions regulated by the Fed.

Having worked on Fed nominations as a staffer for the Senate Banking Committee, I’d be the first to say that the Senate has too often rubber-stamped a President’s Fed nominees.  Recent years have witnessed an improvement in Senate due diligence, but far more needs to be done.  Changes in the norms behind Senate consideration may not be durable.  Accordingly changes to the selection process for the FOMC are badly needed.  I agree with Sen. Warren, the Fed needs leadership with a “broader array of backgrounds and interests.”  Which means the definition of diversity must also include geographic diversity, educational diversity, and diversity of professional experience.  The quality of monetary policy-making depends on it.