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It doesn’t really matter who chairs the Federal Reserve

Janet Yellen: leader or follower? IMF

The surprising news that Larry Summers has withdrawn his bid to become the next chair of the US Federal Reserve has opened up the big question of who should lead America’s central bank.

The new front runner is Janet Yellen, the Fed’s current vice chairwoman. Most commentators and economists seem to agree that Yellen would be a good choice: she is not as deeply associated with the financial crisis as Summers, she already knows Fed inside out, and her appointment would send positive signals about the role of women in economic leadership.

But there is another question that these wonks have failed to ask: is the leadership of the Fed really that important in the first place?

It seems strange to ask such a question. After all, the Chair of the Federal Reserve has one of the most important and powerful economic policy jobs in the world. Their decisions about interest rates are keenly observed by tens of thousands of entranced “fed watchers” throughout the world. The words of the chair of the Fed are important signals that, no matter how guarded or ambiguous, can swing global financial markets. They also play an important longer-term role in influencing the policies pursued by central banks throughout the world. So on the face of it, the question of who holds the leadership role at the Fed can make a huge difference.

Historical research by economists seems to support the important impact that the chair of the Fed can have on longer-term decision making. What the chair believes about how the economy works is particularly important. One historical study shows that the beliefs and assumptions of successive chairs of the Fed had a big influence on the state of the US economy. The authors suggest that when a person who believed in the importance of keeping inflation low occupied the chair, the economy seemed to do well. When the chair did not think inflation was such an important issue, the economy was heading for trouble.

There is no doubt that ideas and beliefs of chair of the Fed are important. But once in place, the chair will find they are far from free to exercise their judgments about the economy. In fact, they are severely constrained by a wide range of external factors.

Clearly the current state of the economy is one of these. But another vital factor is political pressure. Although the Fed is officially independent of government, politicians clearly play a big role. One study found key decisions were largely constrained by external forces such as the demands of the US congress and in particular the US president. This suggests that chair of the Fed is often led - in subtle and not so subtle ways – by the demands of politicians.

As well as being constrained externally, the chair of the Fed is also deeply constrained by the internal bureaucracy of the organisation itself. The Federal Reserve has a long administrative tradition, with well-established systems and mechanisms for making decisions. These processes are vital to the smooth, efficient and fair process of decision-making.

But they can also take on a life of their own. This is nicely highlighted in a study of the Fed which shows that changes in policy are often more about expanding the reach and size of the organisation’s bureaucracy rather than addressing broader economic issues. What this means is that chair of the Fed is often lead by the bureaucratic imperatives – not the other way around.

In addition to being constrained, leaders might just not be very good at making the right decisions. To test the importance of leaders in central banks, an experimental study simulated decision-making dynamics. They found groups with an assigned leader made worse quality decisions than groups that had no official leader. This is due to a well-known process whereby groups with less structure often challenge assumptions, leading to better quality decisions. This suggests actually having an official leader – in particular a strong one – may result in poorer policy outcomes for central banks like the Fed.

This research throws quite a different light on the current debate about who will be the next chair of the Fed. We need to move beyond our current obsession with leadership, which heaps excessive expectations onto the shoulders of charismatic leaders.

Perhaps the question of who fills this role does not matter so much anyway. They will simply be a figure who is severely constrained by politics and bureaucratic process.

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