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Commentary By Peter Ireland

The Senate Should Confirm Nellie Liang to the Federal Reserve Board

Economics Finance

Last week, President Donald Trump nominated economist Nellie Liang to fill the last vacant position on the Federal Reserve Board. Just like the administration’s previous picks, which include current Chair Jerome Powell, Vice Chairs Randal Quarles and Richard Clarida, and (the yet-to-be-confirmed) Michelle Bowman and Marvin Goodfriend, Liang is exceptionally well qualified to lead our central bank. The Senate should move as quickly as possible to confirm her nomination, as well as those of Bowman and Goodfriend (my former colleague on the Shadow Open Market Committee).

When the prior Chair, Janet Yellen, announced that she would resign from her Board position late last year, the Fed’s seven-seat governing panel was left with just three members: Powell, Quarles, and Lael Brainard. As Michael Belongia and I discussed in a previous essay for E21, operating with less than half of the Board positions occupied placed enormous stress on the Fed. Evidence for that proposition can be seen in the current membership lists of the seven Board committees. With a full slate of seven Board members, each would serve on only two of these committees and act as chair of one. Instead, Brainard now serves on five and chairs four. The Senate is demanding far too much of her, and the other Board members, by delaying the approval of the administration’s nominees.

The Fed plays two critical roles in the economy: it conducts monetary policy by managing interest rates and the money supply, and exercises regulatory oversight over the banking and financial system. I have recently argued on E21 that the Fed’s monetary policymaking strategy could be improved if Powell and his colleagues on the Federal Open Market Committee adopted a specific rule to guide their interest rate setting decisions, but Fed officials have always resisted such calls. Nevertheless, Powell has accomplished the next best thing by describing the Fed’s monetary policy plans in the clearest of terms, avoiding the use of technical jargon and deliberate ambiguity that all too often characterize other central bankers’ public statements. Likewise, the administration’s two other choices—Clarida and Goodfriend—have long emphasized the gains that accrue when the central bank employs a clearer and more systematic description of how it manages interest rates.

“Just like the administration’s previous picks... Liang is exceptionally well qualified to lead our central bank. ”

In its role as bank regulator, the Fed should dispel the popular misconception of the financial system as inherently fragile and in need of constant government support. Price movements, often large and unpredictable, must occur in any market to maintain the balance between supply and demand. Anyone who witnessed the long lines for gasoline during the 1970s knowsthat price controls in markets for goods and services almost always make a bad situation worse. But the same is true in financial markets, where asset prices must adjust, often abruptly, to maintain balance between the supply of funds from savers and the demand for funds by borrowers.

Emphasizing those ideas would help Fed officials redesign the regulatory system in ways that allow market mechanisms to replace the discretion and judgment of individual policymakers. The Fed could, for example, simply require banks to rely much more on equity financing and less on debt, as economists Anat Admati and Martin Hellwig propose in their book, The Bankers’ New Clothes. This would use the threat of bankruptcy and large losses imposed on stockholders to enforce discipline on executive decisions in finance—just as it does in all other industries.

But even if the Fed does not change its approach in the ways I suggest, the Board needs strong leadership to ensure the safety and soundness of the American financial system. To that end, the Trump administration’s most recent nominations will form a very impressive team. Bowman has extensive experience as Banking Commissioner in Kansas and, previously, as a bank executive. Her appreciation of the special challenges that smaller banks face in an increasingly complex and competitive financial system will surely allow her to play a unique and valuable role on the Fed’s Board.

Liang, meanwhile, worked for more than three decades at the Federal Reserve Board. She served initially as a research economist, publishing an impressive array of articles spanning the fields of monetary and financial economics. In fact, some of Liang’s most recent research focuses specifically on the interplay between monetary policy and financial stability. Her insights on this topic will be particularly valuable to the Fed if it continues to adhere to the gradual approach of raising interest rates outlined by Chair Powell. Liang would be quick to recognize that, even if aggregate price inflation remains subdued, a significant build-up of risks in financial markets facilitated by continuing low interest rates might require a more rapid policy tightening.

“The Fed should dispel the popular misconception of the financial system as inherently fragile and in need of constant government support.”

In 2010, Fed Chair Ben Bernanke tapped Liang to head the Fed’s newly created Financial Stability division. In that role, she helped design the “stress tests” that the Fed has used to monitor and control risk-taking by the very largest banks. My SOMC colleague Charles Calomiris of Columbia Business School discusses these tests in chapter 4 of his new book on post-crisis trends in financial regulation. Calomiris points out that while stress tests can play a potentially important role in stabilizing the banking system, they could be improved by using better data and models for detecting risk-taking behavior and reformed through better procedures that make them more transparent and easier to understand. No one is more qualified than Liang to implement such improvements and reforms.

The Trump administration deserves credit for moving quickly but carefully to find such excellent appointments to the Federal Reserve Board. Now it is the Senate’s turn to swiftly confirm Liang, along with Bowman and Goodfriend, to bring the Board back to full strength.

Peter Ireland is a Professor of Economics at Boston College and a member of the Shadow Open Market Committee, an independent group of economists organized with the help of Economics21 to discuss and critique the policy choices and strategies of the Federal Reserve.

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