Expectation versus reality
Much commentary on Kevin Warsh's appointment as Chair of the Federal Reserve has focused on what it might mean for US interest rates. The implicit assumption is that a new Chair can quickly reshape monetary policy. That overstates the power of the office.
The reason is simple. The Chair does not set interest rates. The Federal Open Market Committee (FOMC) does. The Committee's twelve voting members decide policy collectively, with each member casting one vote. The Chair is therefore first among equals, not a chief executive who directs monetary policy.
Every new Chair arrives with ideas about how monetary policy should be conducted. Some favour clearer communication, others greater flexibility. Some place greater weight on inflation risks, others on the labour market. But no Chair can simply translate those preferences into policy. They first must convince their colleagues.
The Chair nevertheless occupies an important position. He sets the agenda for FOMC meetings, oversees the Board staff and represents the Federal Reserve in public. These responsibilities give the Chair considerable influence over how policy discussions are organised and presented. But they do not determine the outcome of the Committee's vote.
Influence is earned, not inherited
History suggests that the most successful Fed Chairs earned their influence rather than inherited it. Their authority rested less on formal powers than on their ability to persuade colleagues that their analysis was correct. Credibility was built meeting by meeting, allowing them to forge consensus around policy decisions.
That process cannot be accelerated. Every Chair begins with one vote, just like every other voting member. Influence develops only as colleagues gain confidence in the Chair's judgement and analysis.
The communication paradox
This institutional reality also has implications for communication. Warsh has indicated that he would like the Federal Reserve to say less and place less emphasis on forward guidance. But communication is one of the principal ways in which a Fed Chair shapes expectations, both inside and outside the Committee. If the Chair speaks less while other FOMC members continue to explain their views, the result may simply be that markets pay more attention to those other voices. A vacuum in communication rarely remains a vacuum for long.
Implications for investors
This is one reason investors should be cautious about drawing strong conclusions from the arrival of a new Chair. Personnel changes at the top of the Federal Reserve matter, but they rarely produce immediate changes in policy. Committee decisions evolve as members reassess the economy and, over time, reach a different consensus.
For investors, the implication is straightforward. It is natural to focus on the Chair because he is the public face of the Federal Reserve. But monetary policy is ultimately made by a committee. Understanding how that committee reaches decisions is often more informative than focusing exclusively on the person who chairs it.