YOU DECIDE: Does it matter who heads the Fed?
National attention recently focused on the President's Supreme Court nominees. As one of the three branches of our national government, the court's decisions have major impacts on our legal system and our everyday lives. Plus, vacancies on the Supreme Court occur relatively infrequently. Once confirmed, justices serve for life. It's no wonder every nominee and his or her views are scrutinized in Congress and the media.
President Bush soon will have an opportunity to make another nomination that economists might consider on a par with the Chief Justice of the Supreme Court.
After almost two decades at the helm, Alan Greenspan will retire from the Federal Reserve in January. Although the heads of the Federal Reserve, or Fed, as it's called, don't serve for life, they can be reappointed numerous times. In fact, Greenspan's successor will only be the 13th Fed head since the institution's inception in 1913. So this nomination will be a big deal. The question: Should you care?
I think you should, and not just because I'm an economist. Among all the government institutions in Washington, I'll argue and most of my colleagues will agree that the Fed has the most day-to-day impact on our daily lives. Its policies affect everything from the prices we pay to the wages we earn to how long recessions last. Here's how.
Do you know who controls the amount of money in circulation? If you say the President, Congress, or your local bank, you're wrong! It's the Fed. Through its influence over the value of assets in banks' vaults, the Fed can increase or decrease how much cash circulates.
So do we want someone overseeing the Fed who wants to flood the economy with greenbacks, effectively making us all appear richer? Not really. There's a potential downsize to pumping up the supply of money too rapidly: inflation. If the amount of money spent increases faster than businesses can make things for consumers to buy, prices rise faster, another way of saying higher inflation.
The Fed also can manipulate interest rates, especially on short-term loans. Yet again, there are tradeoffs in pushing interest rates higher or lower. Lower rates favor borrowers, but hurt those investing in certificates of deposit, money market funds and similar investments. The reverse is so for higher interest rates. They help investors, but hurt borrowers. So any Fed chairperson must balance the desires of both borrowers and savers in setting short-term interest rates.
Then there's the influence of the Fed on the economy's business cycle. To understand this, think of the economy as a party. We'd like everyone to have fun at parties (for the economy, we'd like people to have jobs and prosper). But too much fun and frivolity can get parties out of control, possibly leading to drunkenness and fights (in the economy, too much spending can lead to inflation, speculation and market plunges). On the other hand, a dull party can leave people disappointed and unhappy (as in an economic recession).
Think of the Fed as the party's chaperon. It uses its powers over money and interest rates to try to keep the party going on an even keel, avoiding the ups and downs of booms and busts. But this is as much of an art as a science, and past Fed heads have approached this responsibility differently. For example, when the economic party needs controlling, some like the quick, lights-out approach. Others like the gradual tack of talking revelers into moderation.
Sometime in the next couple of months you'll hear about the President nominating a successor to Fed chief Alan Greenspan. I'll certainly pay attention.
You'll have to decide if you will, too.
Dr. Mike Walden is a William Neal Reynolds Professor and extension