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Tuesday, September 20, 2005

Everything You Ever Wanted to Know About the FOMC, and More…

This is something I'm collecting for a class, but it seemed timely given today's FOMC meeting.  This set of remarks from Laurence H. Meyer, who at the time was a governor of the Federal Reserve, looks at how the FOMC was created  followed by a detailed account of what happens from the moment a member of the committee walks though the doors of an FOMC meeting:

Come with Me to the FOMC , Lawrence H. Meyer:…Now some historical background. The Federal Reserve Act, passed in 1913, was "virtually devoid of policy prescriptions" and there were, in particular, no guidelines for the conduct of open market operations.  The role of the Federal Reserve was viewed as more passive than active. The emphasis was on the provision of currency and reserves to meet seasonal demands and on assisting the banking system to accommodate the needs of commerce and business … the discount rate and the discounting of eligible bank loans were the central tools of the Federal Reserve in the early days.

The impetus for open market operations was the experience in the early 1920s when bank rediscounting had declined to a very low level and the Federal Reserve Banks needed another source of revenue to cover their costs of operation. The Federal Reserve … does not receive an appropriation from the Congress. Instead, it earns enough from its operations to cover its expenses and returns any surplus to the Treasury. We credit Treasury on a weekly basis. In the absence of revenue from its rediscounting operations, the Reserve Banks began to purchase government securities…

As they came to appreciate the need for coordination … they established, beginning in 1922, a series of committees to manage and coordinate these operations. The committees, initially consisting of five Federal Reserve Bank Governors (the equivalent today of Federal Reserve Bank Presidents), made recommendations about open market operations which were then subject to the approval of the Board of Governors. However, even if approved by the Board, the Reserve Banks were not required to carry them out. Very messy, very cumbersome, and very unsatisfactory--though, in practice, the Reserve Banks did, in most cases carry out the operations recommended by the committee and approved by the Board.

After a lengthy debate, the Congress decided to establish the FOMC in its present form in 1935. The Reserve Banks were thereby required to carry out the operations as directed by the FOMC. ... The FOMC is a mix of Presidential appointees--the seven Governors--and Reserve Bank presidents who are selected by their respective Boards of Directors subject to approval by the Board. The Boards of Directors of the Reserve Banks have nine members, six of whom are selected by the member commercial Banks in the respective Districts and the remaining three are selected by the Board of Governors. The FOMC is therefore a blend of a national board and regional input of private and public interests…

Now, he moves on to the detailed look at an FOMC meeting (I cut pages and pages out of this, such as what day documents arrive at his house, but I should warn you that it's still pretty long):

So come with me to the FOMC.

It is 9 am on one of eight days, usually Tuesdays, during the year when the FOMC meets. The Federal Reserve Act mandates that there be at least 4 meetings each year and the number of meetings has varied from 4 to 19 over the years. Since 1981, the FOMC has met 8 times each year. Meetings generally begin at 9 am and continue until about noon to 1 pm. Twice each year, prior to the Humphrey-Hawkins report and testimony, the FOMC meets over a two-day period. But I am getting ahead of myself. Our first meeting will be of the one-day or more precisely one-morning variety...

I will never forget the first time I entered the Board room to take my place around the table. Each member appreciates the heavy responsibility the Committee has for the economic well-being of the country and the importance of their personal participation in this process. ... Serving on the FOMC is, without question, the most important responsibility I could have for which this career has prepared me. 

As you enter the Board room, you will undoubtedly be struck by the impressive size of the oval table--27 feet ½ inch long and 10 feet 11 inches at its widest point. Members of the Committee and staff are milling around, greeting each other, but generally not talking much shop at this point. Just before 9 am everyone moves to their respective chairs, just as the chairman, Alan Greenspan, walks in to take his place at one end of the table. The Chairman, by the way enters from a door that connects to his office, one of the perks of being Chairman. I, on the other hand, have had to walk down the long corridor to enter through the main door of the Board room.

To the Chairman's right is the Deputy Secretary of the FOMC. To the right of the deputy secretary is the President of the Federal Reserve Bank of New York ... The remaining Governors of the Board sit in a pre-established order. Just so they don't get it wrong, their names appear on plaques on the chairs. ... The Reserve Bank presidents then sit around the table in a prescribed order that no one can seem to remember the logic for.

Only five of the presidents vote at a given meeting. The voting members are established at the beginning of each year. Initially, the Banks were separated into three groups of two and two groups of three, with one representative from each group selected by their boards of directors. In practice, that meant a rotation of each bank, some every other year and some every third year. But the New York Bank's position was deemed so important … that the President of the New York Fed was, in practice, always selected as a voting member of the FOMC. The unfortunate President of the Boston Fed, the other member of that two-group, therefore, never got to vote. That was, after some experience, judged to be unfair to Boston and the Congress amended the law in 1942 to make the New York Bank a permanent member of the FOMC and to put the Boston Bank into one of the other groups, leaving three three-groups and one two-group to govern rotations of the remaining eleven presidents.

Senior staff of the Board and of the New York Federal Reserve Bank sit at the far end of the table. I will introduce them as they participate in the meeting. In addition, sitting in chairs around the outer walls of the room are additional staff from the Board and the Reserve Banks. Each President, except for the one from New York, is accompanied by one staff member, usually the Bank's Director of Research. The New York delegation includes, in addition, two officers from the Open Market Desk and the Committee's Deputy General Council. Additional senior staff at the Board attend the meetings also. It is rare that any of these attendees speaks at the meeting, although there are specialists in key areas that are there in case they might be needed. Access to the FOMC meeting as well as to the material presented to the Committee in preparation for the meeting is carefully and strictly limited…

The Chairman calls the meeting to order and we are under way. The green light goes on in front of the deputy secretary, indicating that the meeting is being recorded. The first order of business is approval of the minutes of the previous meeting. ... Quite often, small changes are made in advance of the meeting. The minutes are then almost always routinely accepted by vote at the start of the meeting.

The first substantive agenda item is a presentation by the Manager of the System Open Market Account at the Federal Reserve Bank of New York ... His presentation covers developments in the domestic financial and foreign exchange markets and provides details of open market operations and any foreign exchange rate intervention during the period since the last FOMC meeting. … Up next is the Director of Research and Statistics at the Board … who presents the Board staff's forecast. He may share the honors with the Director of the Division of International Finance, … especially when international developments are particularly important in shaping the economic outlook, as has been the case from the onset of the Asian crisis…

The forecast is put together by a group of about 25 staff members, beginning about 10 days before the FOMC and usually concluding the Wednesday before the meeting. It is circulated at the Board early on Thursday and arrives at the Reserve Banks during that day. It is a judgmental forecast, constructed with the help of a variety of equations … The staff appreciates that its role is not to forecast or prejudge the policy decisions of the Committee. ... The forecast … reflects the staff's assessment of how the economy will evolve in the absence of any change in policy today or at subsequent meetings over its forecast horizon, which typically includes the remainder of the current year and the following year. This can be a very effective device for making decisions about policy. The FOMC gets the staff's view of what will happen if there is no change in policy and if they judge this outcome both credible and unsatisfactory, they have the necessary motivation for action to change policy. However, on those occasions where it appears clear that a constant funds rate would be greatly at variance with the Committee's objectives, the staff will incorporate into the forecast some judgment about the change in the funds rate over the forecast horizon.

Whose forecast is this? …it is very clear today that the forecast is the staff's independent judgment. That judgment is, to be sure, influenced, as is appropriate, by ongoing discussions with the members of the Board and the less frequent discussions with the FOMC. But the fact is that there are really twenty forecasts on the table, as it were, at an FOMC meeting. Each President comes with his or her own forecast, developed by the economic staff of that Bank. Each of the Governors comes with his or her own implicit or explicit forecast. None of the other forecasts is put together in so much detail, by so large a staff, and represent as many hours of careful work as that by the Board staff. Neither the Chairman nor the other members of the Board interfere with the staff's exercise of its important responsibility to use its best judgment to provide all the members of the FOMC with a careful forecast.

…At the conclusion of the presentation on the staff forecast, the Chairman asks if there are any questions for the staff. Most of the questions will come from the Reserve Bank presidents because, as I just noted, the Governors have already had the opportunity to raise questions with the staff … At the conclusion of the questions, we begin the first of two go-rounds, the core of the meeting. Each member of the FOMC presents his or her own views on the outlook in the first go-round. The current practice is that Bank presidents generally go first, because they have information that the governors do not have--information about developments in their own regions. The presidents, in addition to having regional information, also tend to have real-time information about consumer spending, business investment, and wage and price developments, for example, gathered from speaking to firms in their Districts. ... The presentations are generally about five minutes long and focus on a few key points that the Committee member feels are of importance to the policy problem of the moment. The presentations do not offer detailed alternative forecasts, compared to the staff, but Committee members often seek to position themselves relative to the staff forecast--stronger or weaker growth, higher or lower inflation, etc.

How the chairman participates in the meeting has changed over time, depending on the preference of the incumbent. Alan Greenspan does not participate in the outlook go-round.

There is not much in the way of exchanges between members of the Committee during this process. Each member speaks, then gives way to the next. Many speak from a prepared text or a detailed outline, although there is a more than an occasional effort by each member to relate his or her remarks to what has gone before. Still, the process is not one of discussion but of a series of self-contained, only sometimes interrelated, presentations.

At the end of the outlook go-round, it's time for a coffee break. …
The Committee is now reassembling to hear the presentation on policy options by the Director of Monetary Affairs, currently Don Kohn, who, by the way, also serves as Secretary of the FOMC. The policy options were detailed and circulated to the Committee in advance in a document called the Bluebook … Don Kohn's discussion will outline policy options, with the emphasis on the plural. He will not recommend a particular course of action to the Committee. Rather he will offer options and provide a coherent rationale for each of the options offered. This has not always been the practice, however… The Bluebook might discuss as many as three options. Option A is always a decline in rates. Option B is always no change in the target funds rate. And option C is always an increase. Depending on the circumstances, the Bluebook may explicitly offer only two options. That is, in cases where it appears clear that the decision will either be to hold rates constant or to increase them, the staff will not offer an option of a decline. No matter. The FOMC is free to make any decision it wants, whether or not the staff has identified that option. In addition, the staff options will also indicate an amount of change--typically 25 basis points or 1/4 percentage point, but sometimes 50 basis points.

The second policy decision that will be made at the meeting is more subtle--a decision between what is referred to as a symmetric and asymmetric posture. This involves two issues. First, is there only a remote chance for a change in policy or a somewhat greater chance for a change in policy in the period between this and the next meeting? A symmetric directive implies less chance of a move during the inter-meeting period than an asymmetric directive. Indeed, some would interpret an asymmetric directive as providing more of a license for the Chairman to change policy during the period between meetings, while a symmetric policy is more limiting of the Chairman's discretion. But … in any case, the FOMC, at least this FOMC, will expect to be consulted--in the form of a telephone conference call--in advance of any policy move. A second interpretation of the directive is information on whether the next policy move is more likely to be up than down. This is like a reminder to the Committee that a policy action might be in the offing…

After the staff presentation of policy options, the Chairman offers Committee members the opportunity to question Don Kohn on issues related to his discussion of the policy options. Then we are ready for the second go-round, this one on policy. The difference in this case is that the Chairman goes first. He will lay out his view of the outlook and then bridge to his policy prescription. This presents the link from the earlier outlook discussion to the current policy decision and it gives the Chairman the opportunity to lead the Committee, both toward the position he is advocating and toward a consensus. This is followed by each of the members, in no prescribed order… laying out views on the policy decision, commenting on both the target funds rate and whether the posture should be symmetric or asymmetric. When the decision is quite clear, there may be very little discussion during this go-round with members mainly indicating their agreement with the position recommended by the Chairman. In cases where the decision is less clear, there will be individual presentations. Many differing views are presented in the outlook go-round and, where circumstances justify it, in the policy go-round. There is encouragement for each member to clearly present his or her own perspective.

Now the critical moment is approaching, the time to vote. Here two traditions come into play. The first is that the Chairman is always expected to be on the winning side of a policy vote. There has not been a case within memory where the Chairman has not been on the winning side of a policy vote at the FOMC. The Chairman is likely to have a good idea of how Governors are leaning, even before the meeting. Board members discuss the appropriate course of policy on occasion at their regular weekly meetings … especially on those occasions preceding FOMC meetings. In addition, the economic and policy situation naturally comes up in informal individual discussions between Board members. Moreover, as all the FOMC members give their views on the economy during the first part of the meeting, the outlook go-round, one can often infer their likely vote--though there are surprises from time to time.

A second tradition is to try to reach a consensus on the policy decision. It is quite common for there to be differences of opinion and yet a unanimous vote. This would be the case, for example, where the question was one of timing rather than of principle. Unanimous votes are common. One or two dissents are not unusual, but more than two dissents at a meeting are rare.

Because of these two traditions--that the Chairman is always on the winning side of a vote and that the Committee strives to reach a consensus--the Chairman's presentation at the start of the policy go-round is so important. It is the key moment, other than the vote itself at the meeting. There is a special sense of anticipation here because the Chairman often will provide some new data or some new insight in support of his position. Indeed, the Chairman is the most likely of the Committee members to challenge the group with a new way of thinking about recent developments. The Chairman presents a very forceful and clear argument for a specific policy recommendation. The recommendation, nevertheless, might be more decisive in the direction and size of the move than with respect to whether the posture should be symmetric or asymmetric. The focus of the comments that follow are why members agree, would prefer another course but can accept, or strongly disagree with the Chairman's recommendation.

When the policy go-round has been completed, the Chairman summarizes his sense of the consensus. For example: No change in the funds rate (option B) and a symmetric directive. Next the directive to be voted upon is read by the deputy secretary, conforming to the outcome of the discussion. The directive identifies the target funds rate and whether policy is symmetric or asymmetric...

Now it's time for the deputy secretary to poll the Committee. The Chairman votes first, the Vice Chairman second, and then other voting members vote in alphabetical order. This is the first and only occasion when the Reserve Bank presidents are treated differently depending on whether or not they are voting at that meeting. Up until that point, all have participated on equal terms in the discussions. Of course, when the chairman gives his sense of the consensus, he is assessing the consensus of Committee members only.

Finally, if there is a change in policy, it will be announced, at 2:15 pm that afternoon. The announcement indicates the new intended federal funds rate and also provides a brief rationale for the policy change. The Committee has delegated the wording of the announcement to the Chairman, but he will read it to the Committee and take account of members' suggestions. If there is no policy change, the announcement is simply, "The meeting ended at 12 noon. There is no further announcement."

What I have covered is really the mechanics of the meeting. But there are subtle issues of interest that I want to turn to now. One of them concerns setting the stage for subsequent meetings and decisions. I've described the discussion as focused on whether or not to change the federal funds rate at the current meeting. But, speaking for myself, a major part of my presentation focuses on subsequent meetings and decisions. Decisions to change policy have a way of evolving from one meeting to the next. The seeds are sown at one meeting and harvested at the next. I listen intently to the input of the other Committee members, but I am mainly gathering input into the formation of my decision for the next meeting. And, in my presentations, I am trying to emphasize the factors I believe will shape the decision at the next meeting. Thus the FOMC process must be thought of in this dynamic sense. One meeting helps to shape the decision of the next meeting.

... The … issue this raises is whether the Chairman controls the outcome to the point where no one else on the Committee matters. While this is clearly an exaggeration, it would be just as silly for me to respond: "What do you mean? I have one vote, just like the Chairman." This is true, of course, technically. But the reality is that the Chairman in general and a highly respected Chairman like the present one has a disproportionate influence on the outcome. Many members will voice some disagreement in the go-rounds with the Chairman's view of the outlook or policy recommendation, but many of those will vote with the Chairman in the end. That partly reflects the importance of consensus and it partly reflects the respect accorded the Chairman. But there is a limit to how the Chairman's influence can be extended and a good Chairman never oversteps this boundary. A good Chairman sometimes has to lead the FOMC by following the consensus within the Committee.

Let's take a quick look in on a two-day meeting. The two-day meetings occur in February and July … We will take a brief look in at a typical February meeting. It begins differently from all the other meetings. The Chairman opens the meeting by calling for nominations for Chairman of the FOMC for the coming year. The procedure is then to turn the meeting over to the next most senior Board member--or the Vice Chair of the Board if there is one--for the election process. You see, the Federal Reserve Act does not automatically make the Chairman of the Board of Governors the Chairman of the FOMC. When the senior Board member asks for nominations, there is typically a couple of seconds of silence. We like to make the Chairman squirm a little, just at the thought that the Committee might have the audacity to nominate someone else. But, that thought quickly passes, and someone nominates the Chairman, who is then unanimously elected Chairman. Next, the Chairman, relieved of course at his close victory, asks for nominations for Vice Chairman ...You may now know more than you ever wanted to know about the FOMC...

    Posted by on Tuesday, September 20, 2005 at 12:15 AM in Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (0)


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