The Federal Reserve is center stage again. The central bank has raised the benchmark interest rate three times since December and is expected to do it again this year. For most Americans, how the Fed operates is a bit of a mystery. The agency and its leaders are also largely blamed for missing the signs leading up to the 2008 financial crisis. Danielle DiMartino Booth, who was an analyst at the Federal Reserve Bank in Dallas and adviser to that institution’s president, Richard Fisher, talks about the issues in her new book, Fed Up: An Insider’s Take on Why the Federal Reserve is Bad for America. DiMartino Booth, who is also founder and president of the Dallas-based economic consulting firm Money Strong, spoke to Knowledge at Wharton about her perspective.
An edited transcript of the conversation follows.
Knowledge at Wharton: Playing off the title of the book, what do you think is wrong with the Fed right now?
Danielle DiMartino Booth: I think the Fed is overpopulated by a singular school of thought that has in the past blinded it to crises as they’re coming our way because they have such a unitary mind frame and singular way of approaching monetary policymaking.
Knowledge at Wharton: Let’s go back to 2007 for a minute. What did they miss?
DiMartino Booth: Ben Bernanke said that it was important to know of the fire code, but that he would rather be the fireman. I found this comment to be very insightful because, since Alan Greenspan was chairman, the thinking has always been that the Fed cannot do anything to address a bubble, even if they have identified one. They can only come in in the aftermath of the bubble and clean up the mess. I think that philosophy is inherently broken.
Knowledge at Wharton: What does it take to jump ahead of something like this?
DiMartino Booth: I think it takes a broader appreciation. Richard Fisher and I, we both have our MBAs in finance and started off on Wall Street. We weren’t intimidated by the financial markets, but we certainly have an appreciation for how the financial markets interacted with monetary policy in addition to economic data. I think it’s having a more holistic view that would have helped policymakers see what was coming. But instead of studying junk bond spreads in addition to inflation below target, they were just looking at the economic data. That’s why they got sideswiped.
Knowledge at Wharton: Do you the Fed is on a good path with the rate hikes this year and more expected?
DiMartino Booth: I think it would have been a great idea to be on this aggressive monetary tightening path about three years ago. That is when Janet Yellen’s favored Labor Market Conditions Index, which she actually created, was gaining momentum as opposed to February 1, which marks the anniversary of the third-longest economic expansion in post-war history. It’s clearly apparent that there are a lot of economic data, car sales being the primary one right now, that are telling us that this economic cycle has peaked and rolled over. You have to sit back and ask yourself, “Why now?” Unless it’s purely paying catch up, or playing politics.
Knowledge at Wharton: Talk about the Fed and its relationship with Wall Street right now.
DiMartino Booth: The way I look at it is, the tail wags the dog. There is an under-appreciation and a lack of understanding of the financial markets, so more often than not we end up with the tail wagging the dog. In other words, central bankers have become very reactive to the financial markets as opposed to being agnostic to them and truly adhering only to safeguarding their dual mandate.
“This is not some kind of secret order of bankers out to destroy the world.”
Knowledge at Wharton: Transparency is one thing, but you would like more Americans to better understand what the Fed is doing and why. Correct?
DiMartino Booth: Absolutely. I think there are way too many conspiracy theories out there about the Fed, precisely because it’s misunderstood. There’s really nothing complex. This is not some kind of secret order of bankers out to destroy the world. I always giggle and get a kick out of the people who feed the public’s fear about the Fed. But at the end of the day, they leave it as a black box. It is not a black box at all. These are people who are studying mainly the Keynesian economic school of thought and applying it to monetary policy.
We’re talking about over a thousand Ph.D.s, if you include the people who are contracted to work at the Fed. Study after study has shown that what is broken globally in monetary policymaking is that so few schools of thought enter central banking aside from the lower-for-longer, the quantitative easing, the unconventional — even though the Japanese have clearly showed us over the years what it means to push on a string.
Knowledge at Wharton: What is your reaction when you hear comments such as the one President Trump made during his campaign about the Federal Reserve being a political entity?
DiMartino Booth: I understand it’s a recovery, but you’re talking about 1.8% since we came out of recession. It’s nothing to write home about. I’m of the opinion that the Fed has facilitated misfeasance on Congress’s part by taking the onus off of fiscal policymakers to do their job. It’s ridiculous.
Knowledge at Wharton: If the changes had been made three years ago, like you suggest, do you think we’d be looking at 2.5% to 3% growth on a routine basis?
“Business cycles are cyclical because they end up achieving what capitalism does.”
DiMartino Booth: I do. I also think that we might have gone into recession. There’s a very high probability that that would have been the case. But that’s OK. That’s why business cycles are cyclical, because they end up achieving what capitalism does. They end up taking the wounded buffalo out of the herd and making the operating environment for really efficient competitors that much better when you’ve come out of it, laying the groundwork for much faster growth.
Knowledge at Wharton: Before Ben Bernanke was Alan Greenspan, who is seen by many as a legendary figure. You write about the impact of Greenspan in this book. Talk about his place in this process.
DiMartino Booth: He’s the one who made the rules. He wrote the rule book when you consider the fact that August of this year would have marked his 30-year anniversary of entering the Fed. He entered the Fed two months before the market crashed. It was his reaction to the 1987 market collapse that set the basic philosophy of central bankers inside the Fed going forward. That is, you make sure that no matter what happens you put a floor under investor losses. In the book, I write about the so-called Greenspan Put that was born, placing a floor underneath your losses, as buying a put option would in the market. But I stated it was the establishment of the Greenspan Put that really did put investors in the driver’s seat at the expense of your average working Joe.
“I would be remiss to have the Fed become an institution that was driven by one model in order to be disciplined.”
Greenspan’s biography was released after my book had been written. But his biographer, who was basically embedded with him for two years, came out with the conclusion that Greenspan didn’t want to disappoint the politicians and his revering public. These are things that he has said and regrets … in terms of feeding the bubble mentality.
Knowledge at Wharton: How do you gauge your former boss, Richard Fisher, and the job he did with the Dallas Fed?
DiMartino Booth: I have tremendous respect for him, especially when you go back and read the transcripts of the sheer level of pushback that he encountered year after year after year. He had several allies along the way, Jeremy Stein being one of them, whom I find to be a fantastic individual. Charlie Plosser at the Philadelphia Fed. There were other people fighting alongside Richard Fisher, but I have tremendous respect for the fact that he never was kowtowed by the armies of academics.
Knowledge at Wharton: Is the Federal Reserve a political entity?
DiMartino Booth: Oh, I think it’s absolutely a political entity. One of the individuals who’s just announced he’s going to be resigning had his Obama presidential sticker on the back of his SUV the entire time he’s driving into the garage of the Federal Reserve. Another one of the individuals who’s still on the board publicly gave to Hillary Clinton’s campaign. I’m not making a political statement in any way, shape or form. But the individuals, the leadership of the Federal Reserve is mandated to be apolitical.
Knowledge at Wharton: It’s almost an institution that can’t avoid being political right now.
DiMartino Booth: That needs to change. Like him or not, if you want to have a secretary of state who’s not going to be intimidated by Middle Eastern leaders, then appoint somebody who negotiated with all of them throughout the Arab Spring. There are intuitive ways to bring in individuals who do not have an agenda, who are far enough along in their careers to not be trying to espouse to any one particular political leaning. They’re out there. One of the things I write about at the end of the book was in my prescriptions about how I would upend the Fed — not end it, but change the institution.
Knowledge at Wharton: Does the Fed make decisions based on what’s good for America or what’s good for the globe?
“There was once a time that the Federal Reserve could make monetary policy in a vacuum solely for the United States. That is no longer the case.”
DiMartino Booth: I don’t think that the Fed has a choice anymore. What happened in August 2015, when the People’s Bank of China devalued the yuan, really did change the rules of engagement for every central bank in the world. There was once a time that the Federal Reserve could make monetary policy in a vacuum solely for the United States. That is no longer the case. As we learned during the subprime crisis, and as the Chinese reminded us, we’ve become a very globalized, interconnected financial system that is susceptible to systemic risk.
Knowledge at Wharton: What are the things that the Fed should be thinking about changing to make it better?
DiMartino Booth: I think that the 1913 economic map of the United States no longer applies. The district lines of the Fed need to be redrawn. I think that one of the main reasons that the crisis was so acute is that the San Francisco Fed was incapable of monitoring and regulating the entire district — what used to be the Wild West back in 1913. I think we need to add a Federal Reserve district there. I think the Midwest could logically absorb three such that we came down to 10 total, including the New York Fed. And at that point, give them all permanent votes, as opposed to having district presidents rotate off of voting every three years. The state of California, the state of Texas, the two largest in the country, don’t cease to be relevant economically every three years, and I think the presidents should have a permanent vote as such.
I would also cut the mandate right in half, undo what was done in 1977, which obviously would take an act of Congress. But take the Fed back to having a singular mandate of minimizing inflation, making sure that the dollar in your wallet buys tomorrow what it would buy today. Those are just some of the things. And as I mentioned earlier, putting independent practitioners who’ve been on the receiving end of interest rate policy, populating the Federal Reserve with them as well, mixing it up some.
Knowledge at Wharton: I’m going to give you 10 minutes with Janet Yellen in a closed room. What do you tell her?
“If you see Janet Yellen testify in front of Congress, her eyeballs are apt to roll into the back of her head.”
DiMartino Booth: I tell her it’s high time that she go get an executive MBA in finance from Wharton! She does not understand banking supervision, regulation. If you see her testify in front of Congress, her eyeballs are apt to roll into the back of her head. And I don’t think she really wants to understand a lot of the things that are essential for a Fed leader to have all of the knowledge that they need to run the institution. She’s a labor economist, and her focus tends to be on that second mandate of maximizing employment. But that has blinded her to the fact that trying to pull that next marginal worker back into the workforce is going to cost the economy more in the end because of the financial stability that low interest rates bring about.
Knowledge at Wharton: Who are you putting as the early candidate to replace her?
DiMartino Booth: My former boss’s name has come up, as has that of Kevin Warsh, as has that of John Taylor of Stanford, of the Taylor Rule. I’ll throw something in there. I think John Taylor is a brilliant man who’s got great ideas. But I would be remiss to have the Fed become an institution that was driven by one model in order to be disciplined. Again, you need a wide variety of viewpoints. It’s mandated in the 1913 Act that the President appoint individuals from a diversity of industries and geographies. I think that’s the one part of the 1913 Act that we should keep and adhere to.
