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Shadowing the Shadows

The Shadow Open Market Committee has persistently, and faithfully, trailed its Federal Reserve namesake for 20 years

June 1, 1993


Shadowing the Shadows

Pity the person who must write a press release each week that summarizes a preacher's sermon; after all, the message is essentially the same—week after week, year after year.

That's how one member describes the job of the Shadow Open Market Committee (SOMC), a group of business and academic economists that gathers twice a year to comment on the policies of the Federal Open Market Committee (FOMC), which conducts the country's monetary policy. For 20 years the message of the SOMC—which has no public affiliation and is funded through foundation grants—has been the same: It is more important for the FOMC, in its efforts to control inflation, to pay attention to the growth rate of money rather than to movements in interest rates (or other economic indicators).

The views of these monetarist economists are accorded more weight today than in 1973 when the first SOMC gathered and Keynesianism was the vanguard. The increased acceptance of monetarist views is due in part to the work of economists who have served on the SOMC over the years—especially founders Karl Brunner and Allan Meltzer—as well as others like Milton Friedman.

However, like the preacher who after many years still finds his church barely half-full, monetarism does not dominate policy debate and the SOMC continues its efforts to convert the heathen. Consider this rebuke of the Federal Reserve at the SOMC's latest meeting, March 1993: "... the Federal Reserve now bases its actions on changes in the real economy, particularly changes in the unemployment rate. This procedure ensures that the Federal Reserve will fail to act in a timely way to prevent a rise in inflation."

Even in 1980, when the FOMC moved toward the use of monetary aggregates to set monetary policy, the SOMC was skeptical: "... there is no evidence yet that the Federal Reserve can be relied on to reach announced targets consistently. Current procedures generate avoidable uncertainty and should be improved promptly."

And in 1973, when it announced its formation, the SOMC's message set a tone for the coming years: "... there is little doubt that, on balance, government policies have increased economic instability during recent months and during the past eight years. The failure to control inflation was not inevitable."

Meltzer and Brunner, heart and soul

Without exception, current and former members of the SOMC mention the privilege of having served with Karl Brunner, who died in 1989, and working with Allan Meltzer, economics professor at Carnegie Mellon University in Pittsburgh and chairman of the SOMC, as a major inducement to joining the group. Brunner was educated in his native Switzerland and came to America in 1943, where he spent time at Harvard and the University of Chicago before teaching at UCLA and Ohio State University; in 1971, he moved to the University of Rochester in New York. It was at UCLA, where Meltzer was a student, that the two economists began a collaboration that endured throughout Brunner's career.

Brunner and Meltzer started the SOMC in 1973, but it had its genesis in 1971 when, "out of a sense of frustration," they enlisted about a dozen economists to sign a statement of opposition to the newly imposed wage and price controls.

But Brunner and Meltzer didn't think the statement garnered enough attention. So, two years later, they decided that a group of dissenting economists, meeting regularly, would have a better chance of reaching the public. "We wanted to talk to a public audience, not an academic audience," Meltzer says.

To the extent that the SOMC has succeeded in focusing attention on monetary policy over the years, Erich Heinemann says the credit is due to Brunner and Meltzer. Heinemann, a Shadow member and an economist at Ladenburg, Thalman & Co. in New York, described Brunner as a "commanding figure" in economics with a "huge intellectual range."

As for Meltzer, Heinemann says his "drive and intellect" keep the SOMC focused. "Our credibility is a function of our analysis," he says, and Meltzer—who sets the SOMC's agenda in consultation with the members—is the committee's guiding force.

In addition to their affiliation with the founding members, Shadow members also say that they like serving on the SOMC because of the chance to regularly rub elbows with the other economists on the committee. Mickey Levy, economist with CRT Government Securities in New York, says he feels privileged to sit on the SOMC, not only to contribute papers and analysis, but to simply discuss issues with the other economists. "The SOMC provides a great network of scholars to interact with and to ask questions about difficult issues. It's a huge plus for me."

Over the years, members of the SOMC who have left the committee while serving in the government have usually gone back to the Shadow after their government service, according to charter member Anna Schwartz, economist at the National Bureau of Economic Research in New York and long-time collaborator with Milton Friedman. The Shadow members share a common orientation, Schwartz says, and the committee offers them an opportunity to refine their views among those with shared beliefs.

In that respect, Friedman—who views the SOMC as an oasis of independent thinking in a desert of conformity—applauds the existence of the Shadow group. He maintains that since the Federal Reserve Board and its district banks hire a large number of economists in the field of money, the central bank has a sort of oligopoly on monetary opinion. In other words, if you want to advance in the field of monetary research, according to Friedman, you would be disinclined to criticize the major employer in the field.

"This problem with the Fed is why the Shadow is so relevant," says Friedman, who has never been a member of the SOMC, even though he usually agrees with the group. "I prefer to work as an individual," he says. "I always thought it would be better for me and better for them," he says of his absence from the SOMC.

Debate is encouraged, challenges are expected

Every March and September, the eight economists (the number has varied between seven and 10) meet in Washington, D.C., for a
two-day meeting that includes a working session and a press conference. (A ninth economist, Jagdish Bhagwati, professor of economics at Columbia University in New York, contributes analysis on trade policy but does not consider himself a monetarist or an expert on macroeconomics; as such, he says he is not a formal member of the SOMC.)

At the working session, which begins on a Sunday afternoon and lasts well into the evening, the economists present papers on particular topics (such as fiscal and trade policy, as well as monetary policy), after which they prepare a policy statement. If the SOMC's March meeting is any indication, debate during these working sessions ranges from points of grammar ("The antecedent is ambiguous") to the most reliable way to measure and predict inflation ("We're not going to settle this tonight").

And debate is encouraged. There is a camaraderie among the Shadow members that makes for interesting and sometimes humorous discussion, but there is also an intellectual rigor that means the economists can expect critiques of their presentations. For example, at its recent meeting, the following statements were typical:

"The way the first sentence reads, it confuses me ..."
"I'm puzzled about your reasoning ..."
"I think that's not right ..."
"Wait, wait, I was trying to be careful ..."
"The problem you run into there ..."
"Just one more question ..."

There's always one more question, and it is Meltzer's job to move the debate along so the committee can complete its work. The debate is sometimes extended because the committee invites participation from those who observe the working session. Economists, business reporters and other interested parties may attend the Sunday session and are welcome to interject with comments or questions of their own. Often, a member of the SOMC will solicit an opinion from one of the observers.

"It's a collegial atmosphere," Meltzer says of the committee's working session. "We have invited that interchange."

The day after the working session, the SOMC releases its policy statement at a press conference, a quick turnaround that was not lost on Lee Hoskins, former president of the Federal Reserve Bank of Cleveland and now president of Huntington Banks in Columbus, Ohio. "I'm used to waiting six weeks," Hoskins joked to the nearly 30 reporters at the March press conference. He was referring, of course, to the FOMC, which releases minutes of its meetings six weeks after they occur to avoid undue influence on the markets. "I believe this sets a healthy example for the Federal Reserve," added Hoskins, who attended SOMC meetings as an observer prior to his years at the Fed.

Even though copies of the SOMC policy statement, as well as the individual papers, are mailed to journalists and economists, the SOMC's press conferences are the primary forum for the group's message. In large part, the SOMC measures its impact by the amount of press coverage it obtains. Over the years, the media's interest in the SOMC seems to have coincided with periods of high inflation; that is, when the Fed is under scrutiny the media is more interested in alternative views.

When times are relatively stable, as they are now, news coverage is often limited. "I don't know how much attention people pay to a paragraph in a newspaper," Schwartz says.

William Wolman, a member of the SOMC in the early '70s and now chief economist at Business Week, says that just because inflation has been relatively under control in recent years doesn't mean the SOMC is wrong. "But it does make it hard for [the SOMC] to present its case," he says.

Regardless of how the SOMC is covered by the media, the news conferences are always well-attended, which attests to the reporters' desire to engage the Shadow members in discussions about the economy. Those discussions continue after the news conference at a press luncheon, which marks the end of the SOMC meeting.

Extending the shadow ...

Over time, to broaden its impact on policy debate, the SOMC began to comment on topics beyond monetary policy, such as fiscal and trade policy. Rachel Balbach, former chief economist at Boatmen's National Bank in St. Louis, who has attended the meetings for many years as an observer, says the group's decision to branch out beyond monetary policy has brought the group more attention. She also says the SOMC's move to Washington, DC, from New York in 1988 for its semiannual meetings has brought more policy-oriented questions from reporters. Many New York reporters were only interested in interest rate speculation, she says.

"Our aim is not to get people to do what we say, but to inform people," Meltzer says. "We're never going to get good economic policies until we get public understanding." When the public is properly informed, he says, the SOMC will be out of business.

If imitation is the highest form of praise, than certainly the SOMC has had an impact. Since the SOMC was formed, a Shadow Financial Regulatory Committee has started, as well as a Shadow Securities Exchange Commission, a short-lived Shadow European Policy Committee, another one in England that used a report by Schwartz as a guide, and the SOMC's Heinemann reports that there is a counter-SOMC that has been established to shadow the original Shadow.

... But for how long?

While the SOMC warns of increased inflation in coming years if the Federal Reserve continues its current policy, Meltzer admits that the reduced inflation rates of recent years—and the concurrent disinterest in Fed criticism—has caused him to ponder the possible demise of the SOMC.

At the same time, though, like Friedman, he recognizes the need for effective analysis and thoughtful criticism of monetary and other economic policies. As Karl Brunner once joked to Meltzer when referring to the abundance of economic problems: "I can see us wandering in here in our dotage with our beards growing to the floor."

  • SOMC paper (September 1992) "The singular distinction between the present funds rate operating procedure and that of the 1970s is that the current FOMC appears to be much more aggressive about implementing changes in the funds rate target, and hence the operating procedure is not characterized by the inertia of the 1970s."

    Robert H. Rasche
    Professor, Department of Economics
    Michigan State University, East Lansing, Mich.

  • SOMC paper (March 1993): "The productivity-driven growth has a highly favorable impact on economic performance. It has increased output while easing pressure on wage compensation, thus generating a dramatic decline in unit labor cost ... Moreover, the productivity gains have raised the international competitiveness of U.S. firms, supporting continued growth in exports."

    Mickey D. Levy
    CRT Government Securities, New York

  • SOMC paper (March 1992): "Some propose a new Marshall Plan [for the former Soviet Union] ... This, too, is a mistake. The Marshall Plan provided capital to market economies in which competition was the norm. All of these economies had legal, financial and accounting systems, property rights and enforceable contracts. None of these institutions are present in the former Soviet states."

    Allan H. Meltzer
    Carnegie Mellon University, Pittsburgh

  • SOMC paper (March 1993): "We also continue to hear reports from Washington and the business press that either more economic growth causes inflation or that inflation is good for economic growth. Neither story has much evidence to support it. ... If anything, the picture indicates that higher inflation rates are more frequently associated with lower rates of real economic growth."

    Charles Plosser
    University of Rochester, Rochester, N.Y.

  • SOMC paper (March 1993): "... the depressing effects of future tax increases will arrive in 1993; the combination of fiscal stimulus and restraint at the same time is equivalent to driving with one foot on the accelerator and one on the brake. This policy is just as bad for the economy as it is for a car."

    William Poole
    Professor, Department of Economics
    Brown University, Providence, R.I.

  • SOMC paper (March 1993): "... there remains the dilemma that no public policymaker—however selected—should enjoy complete autonomy. The answer is to give central bankers freedom of action (independence) in the pursuit of a single, clear, measurable, and attainable objective, while making them answerable (accountable) for the results of their actions."

    W. Lee Hoskins
    Huntington National Bank, Columbus, Ohio

  • SOMC paper (September 1992): "The Fed and other central banks have intervened in the exchange markets to slow the decline of the dollar. However, central banks have simultaneously executed offsetting transactions in their own money markets to 'sterilize' the effect of the intervention on preexisting domestic monetary policies. This exercise was a silly waste of taxpayers' money."

    H. Erich Heinemann
    Ladenburg, Thalmann & Co., New York

  • SOMC paper (March 1993): "One concern of the U.S. authorities was to resist episodes of either weakness of the dollar vis-a-vis the mark or strength vis-a-vis the yen, however futile the resistance. In January 1992, for example ... the Federal Reserve and Treasury Exchange Stabilization Fund shared a $50 million yen purchase equally."

    Anna J. Schwartz
    Economist, National Bureau of Economic Research
    New York