Two sharply contrasting visions of the future of the Federal Reserve have arisen in Ben Bernanke’s confirmation hearings in the US Senate.

The first is the Bernanke/Geithner model, advocated by the Fed chairman and his former colleague Tim Geithner, Treasury secretary, The Fed would:

• retain its supervision powers over the top banks and gain supervision of any other systemically important financial institutions.
• have a leading role, in concert with a wider council of regulators chaired by the Treasury secretary, in dealing with systemic risk through the exercise of “macroprudential” powers.
• be a fully-fledged financial stability agency as well as a monetary policy agency.

The second is the Dodd model, proposed by Senate banking committee chairman Chris Dodd. The Fed would:

• would lose its banking supervision authorities.
• have a less prominent role in dealing with systemic risk, though it would have a seat at the table in a new systemic risk agency.
• would be more focused on monetary policy.

Which is the better model?

The case for the first model is based not on monetary policy but on financial stability policy:

• During the financial crisis the Fed benefited greatly from its understanding of the plumbing of the banking system. This made it an effective and innovative lender of last resort.
• The Fed would in principle be able to access any information it wants. But flows of information can break down mid-crisis. Moreover, there is a difference between information and the expertise to interpret that information.

International experience supports this case. “One of the main lessons of the crisis may be that those countries where central banks assume banking supervision took advantage of their ability to react quickly and flexibly to emergency situations,” says Christian Noyer, governor of the Banque de France. The Fed may also be the better way to prevent the build-up of threats to financial stability in normal times, through a more system-wide perspective on regulation.

However, genuine political economy concerns arise:

• The wider the Fed’s role and the more it extends even in normal times into sectoral allocation of credit in the name of systemic risk, the more scrutiny is required.
• It is hard to argue that systemic risk policy is so closely intertwined with monetary policy as to be institutionally inseparable and yet suggest that the governance regimes can be completely distinct.

In favour of the second:

• The central bank’s record in bank supervision is far from stellar. There are obvious benefits to consolidating bank regulation.
• Tighter focus on monetary policy would make it easier for the central bank to retain the independence central to effective monetary policymaking.
• The Fed’s claim that being a banking regulator helps it make monetary policy is questionable, as Mr Bernanke more or less conceded at the hearings.

In this model others would decide when to use controls on risk-taking to target emerging excesses. This would be difficult to co-ordinate with monetary policy, which has to respond to the same developments and which operates through the same credit channel.