THE MAESTRO’S BATON: HOW FEDERAL RESERVE CHAIRS INFLUENCE POLICY

Abstract

The history and popular perception of Federal Reserve chairs attribute them with more power over Fed policy than their official duties suggest they have, and the literature on the Fed has not explained this discrepancy. A comparison of two historical chairs demonstrates that chairs hold a large amount of unofficial power and this power varies with the chair’s background and leadership style. This follows research on influence and decision-making from fields like psychology and behavioral finance. This paper describes the chair’s official role in the Federal Reserve System and summarizes the existing efforts to determine the chair’s actual power. It then describes possible ways a chair influences other Fed officials, including psychological factors like prospect theory and biases that defy strict rationality. To control for several variables and track the office’s inherent power, the paper compares the first twelve months of the tenures of Chairmen G. William Miller and Paul Volcker. Using psychological factors, the biographies of these chairs prior to their appointments correctly forecast Volcker was more influential. Qualitative and statistical analysis of Fed documents, especially FOMC meeting transcripts, suggests the chair’s influence follows psychological factors’ predictions and changes across different chairs. The analysis also indicates all chairs have a large amount of power yet even strong chairs do not dominate the Fed. The patterns from Miller and Volcker expect the Fed’s newest leader, Janet Yellen, will expand upon the office’s power as Volcker did. The paper concludes by considering what a powerful chair means for the Fed’s effectiveness.