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The Fed needs more administrators

The writer is an FT contributing editor

On Tuesday Lael Brainard started her new job as the top economic adviser to Joe Biden. This leaves open her old position as vice-chair of the board of governors at the Federal Reserve.

Governors get to vote at every meeting of the Fed’s monetary policy committee, and so Brainard’s replacement will go through the standard political fight for every Fed nominee. Some Democrats will want a quiet, consistent voice for economic growth as a successor. Some will want a loud, defiant voice for economic growth.

Central banks don’t just nudge the price of debt up and down, though. The Fed also does boring, important technical work all over America. Before joining the Fed board, Brainard had already spent time at the White House and the Treasury under two previous Democratic presidents. She trained at Harvard as an economist but worked in Washington as, among other things, an administrator, a skill among central bankers that politicians tend to undervalue.

When central bankers were stunned in 2019 by the sudden announcement of a Facebook digital currency, Brainard managed both the public response for the Fed. And she chaired the Fed’s committee on the most thankless task in banking: payments.

Moving money from one person to another is the oldest problem in finance. We might have been taught that people once just handed coins back and forth, but straight payment with a physical coin has never been the default case in commerce. People kept accounts of what they had delivered, expecting payments on that account to clear sometime in the future. The longer that lag, and the farther apart two people were, the more likely they were to experience liquidity risk — that someone can’t pay when asked — or credit risk — that someone can’t pay at all.

Historically, clearing worked best when everyone was in the same place or even the same institution. Market towns in medieval Europe developed clearing fairs, where merchant bankers would meet regularly to first agree on payments that needed to be made, then physically walk around with their ledgers to see whether any mutual payments could be cancelled. Then and only then would they clear any remaining balances with coins. When New York banks formed their Clearing House in 1853, this process had not really changed; banks sent clerks with ledgers and hand trucks of gold and silver to stand in a room together to clear out and then settle up.

In the 17th century, Amsterdam and Hamburg developed exchange banks, where merchants held deposits within the same institution, and payments cleared on a single ledger. What we now think of as central banks were developed over time, as crowns and nations figured out new uses for them. But in part they developed out of these exchange banks, and to serve the same function.

The 20th-century vision of a central bank is one that manages inflation and employment by encouraging or discouraging private lending. But that’s only a part of what we’ve historically expected from central banks. Liquidity and credit risks remain inherent in payment. And, like the exchange banks and the clearing houses, we still have to decide whether it’s better to have a single public institution help handle that risk, or a private group of banks.

The US, with a few powerful large banks and many widely scattered small banks, has been slower than most other large economies to develop fast payments — where a payment from one person to another clears between banks not at the end of the day or in three days but immediately.

Much of what Americans loathe about banks comes from the slow pace of settlement. Cheques, a technology not much improved from a medieval bill of exchange, still account for just under a quarter of the value of non-cash payments in the US. As the central bank researcher Peter Conti-Brown pointed out in a 2020 paper, smaller transfers in particular clear slowly in the US, making people more likely to face fees on overdrafts or pay a discount to convert a check immediately into cash.

In 2019, Brainard announced that the Federal Reserve would build Fednow, a fast-payment system set to launch, finally, in the middle of this year. She did not will it into existence alone. But she does seem to possess the skill set of moving complex projects forward.

What democracies demand from their central bankers has changed over time. In the early 20th century, it was commercial bankers, with their pragmatic and self-interested focus on tight money. They slowly gave way to the economists, with their inflation and employment models. It is long past time for more administrators, who understand the problems of low finance and care enough to fix them.

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