President Trump has nominated Kevin Warsh for the top spot at the Federal Reserve. Though a former member of the Federal Reserve Board of Governors in Washington, DC, Warsh is out of sync with prevailing views at the central bank. That diversity of thought could improve the Fed’s monetary policy decisions.
Warsh’s candidacy for Fed chair has been widely construed as an effort to further politicize the Fed. The implicit assumption is that Fed policy is better if everyone is in sync. While the media has characterized dissent on the Federal Open Market Committee (FOMC) as controversial or divisive, diversity of opinion often improves the collective decision-making of deliberative bodies like the FOMC. Indeed, my research suggests that groupthink is a real problem at the Fed.
At each FOMC meeting, staff economists at the Board of Governors brief participants on the state of the economy and present forecasts from the Tealbook, most notably the Fed’s FRB/US model. FOMC members then discuss their own observations and vote to raise, hold, or lower the federal funds rate target range — the interest rate that the Fed targets. Four times per year, FOMC members also provide their own projections for key economic indicators, like real GDP growth and inflation. An anonymized summary of these projections is initially released in the Summary of Economic Projections. Attributed projections are released five years later.
In a 2022 paper, I examined the forecast errors for real GDP growth projections made between 1992 and 2016. I found that while diversity of thought improves the accuracy of the FOMC’s projections, for the most part, FOMC member projections conformed strongly to those of the FRB/US model presented by the Board’s staff economists. Note that FOMC members can use whatever information they like when forming their own projections, including forecasts from regional Reserve Bank staff or private sector analysts. In practice, however, they largely defer to the Board’s model.
There are at least two potential explanations for the observed conformity. It may be that the Board’s staff economists produce the best forecasts and, recognizing this, FOMC members defer to them. An alternative case is that FOMC members suffer from groupthink — that is, that members are inclined to accept the Board’s projections by default rather than challenge them with potentially superior externally produced forecasts.
How good are the forecasts produced by the Board’s staff economists? Not good at all.
Indeed, the evidence indicates that groupthink has led to suboptimal monetary policy and relatively worse economic outcomes. Two examples serve to illustrate.
In 2021, Fed officials repeatedly (but wrongly) claimed that the pandemic-era inflation was “transitory.” This caused the FOMC to delay raising its federal funds rate target range in late 2021 and early 2022, and proceed too slowly once it began raising the target range. The Fed’s sluggish response allowed inflation to reach a 40-year high, eroding the real incomes of average Americans. Fed Chair Jerome Powell attributed the Fed’s mistakes, in part, to groupthink, saying “everyone had the same model — which was the Phillips curve model.”
Groupthink was also a problem during the Great Recession of 2007-2009. The FOMC adopted expansionary monetary policy at the start of the recession, but it ceased cutting interest rates in early 2008 as the economy continued to decline. Even as the financial system fell into crisis in September of 2008, the FOMC refused to loosen financial conditions by lowering its federal funds rate target.
As then Fed Chair Ben Bernanke later recounted in his autobiography, “In retrospect, that decision was certainly a mistake.” In fact, it was a mistake that put nearly 15 million people out of work.
Warsh is a strong pick for Fed Chair. His out-of-sync views will bring much-needed diversity to the Fed and help break the Fed’s pervasive groupthink. Making space for different perspectives at the FOMC table will encourage discussion, which will help lead to better policy.
That’s how diversity of thought works — and it is an essential component of effective deliberative bodies. The FOMC is no exception.
