One of the critical functions—maybe the critical function—of the US’s Federal Reserve Bank is to make predictions about the likelihood of inflation. Unfortunately, it’s terrible at doing that.
The Fed doesn’t have a good working theory about what causes inflation, or how to measure it. When it makes decisions to slow inflation with higher interest rates, it often over reacts, as Peter Coy writes in Bloomberg Businessweek. “Five of the seven credit-tightening cycles since 1970 have choked growth and ended in a recession.” Broadly speaking, economists are pretty dreadful at forecasting.
One way to improve an organization’s ability to make complex decisions, like forecasting interest rates, is to introduce diversity to the decision making process. A growing body of research, notably by academics such as Scott Page of the University of Michigan and Katherine Phillips at Columbia, demonstrates that increasing the number and diversity of group makers almost always produces better results—especially when it comes to economists and predictions.
In one study of the predictions of thousands of economists, the best at predicting was 9% better than an average economist, but the averaged predictions of any seven random economists outperformed the average by 20%. Page, the author of The Diversity Bonus, argues that when it comes to economic forecasting, more and different views are better than those of any one expert.
If an organization can’t add to its number of decision makers, it can try to improve the diversity of the group it has, by adding people with different life experiences who can bring their own perspectives to the problem. In a number of studies, racially mixed teams outperformed groups from a single race in problem solving. In one exercise, designed by Phillips and her colleagues, teams of three were given clues to solve a murder mystery. While all team members shared some information, other clues were only known by individuals. The diverse teams did better because they didn’t make assumptions about what their teammates knew, and asked each other more probing questions. “Diversity jolts us into cognitive action in ways that homogeneity simply does not,” Phillips wrote.
The Federal Reserve system currently has an opportunity to diversify its decision making process; William Dudley is retiring as the head of the influential New York Federal Reserve. That position comes with a permanent seat on the Federal Open Market Committee, the panel that sets policy on how to combat inflation. But the man who reportedly is expected to replace Dudley is John Williams, current head of the San Francisco Fed, and a fellow white, male economist.
The lack of different life experiences at the Federal Reserve isn’t just a theoretical problem. Daniel Tarullo, a law professor who served on the Fed’s board of governors from 2009 to 2017, joined without a background in macroeconomics. While he initially thought that would be weakness, he realized it was a strength, he wrote for the Brookings Institution. His lack of formal training meant he could ask questions that challenged assumptions, which was helpful given that conventional thinking helped lead the economy to the precipice during the financial crisis.
“I think my experience argues for a conscious effort to assure some diversity of experience and intellectual background on the FOMC,” he wrote in October.
The news of Williams’ possible appointment is being challenged by activists and politicians, like New Jersey senator Cory Booker, who say the bank’s board is missing an opportunity to appoint the New York Fed’s first woman or non-white president. It may also be missing an opportunity to make the Fed better at its job.