By Rob Cox
NEW YORK (Reuters Breakingviews) - There are two things the next leader of the Federal Reserve must prepare for: a recession and a public beating. The first is a statistical likelihood. The second, however, is a bankable certainty. If there is anything predictable about President Donald Trump, it is his willingness to bully institutions with authority separate from his own. And the U.S. central bank’s effectiveness relies on its independence.
The challenge for whoever leads the Fed after Janet Yellen’s term expires early next year, however, won’t be confined to withstanding intemperate early-morning tweets from a White House boudoir. Since the financial crisis the Fed, like its cousins in Japan, the European Union and elsewhere, has stepped in when fiscal policymakers have not. The next chairperson may also have to push the burden of taking action back to Congress.
Yellen could yet be Trump’s safe fallback choice, but he’s also considering current Fed Governor Jay Powell, former Governor Kevin Warsh and former Treasury official John Taylor. Much of the debate about the candidates, at least up to now, has focused narrowly on their hawkishness or dovishness – Fedspeak for a preference for raising the cost of money on the one hand or for keeping it cheap and plentiful on the other. Yellen’s Fed leans towards the doves, as did the institution under her predecessor Ben Bernanke.
Monetary policy matters. Raising rates too abruptly can stifle economic expansion. Pumping too much money into the financial system risks widespread capital misallocation. The potential for a Fed chair to either crush growth or inflate bubbles is what makes the job best suited for highly intelligent, risk-averse people of considered judgment. All the candidates, being Ivy League-educated students of economics with a preponderance of degrees from Princeton and Stanford, fit this bill.
To investors who obsess over such matters, small differences in their views on the trajectory of interest rates or the pace at which the Fed’s $4 trillion balance sheet should shrink are a big deal. To ordinary citizens, though, these are technical quibbles. What the electorate may care about more is keeping the Fed cushioned from day-to-day politics. Fed independence, both perceived and perhaps to a slightly lesser extent real, has proven crucial to the role of the bureaucrats in the Marriner S. Eccles Building in Washington.
Paul Volcker, who literally towered over both the Fed and politicians from 1979 to 1987, once argued it this way. “The credibility of the Federal Reserve, its commitment to maintaining price stability, and its ability to stand up against partisan political pressures are critical. Independence can’t just be a slogan.” The central banker who raised interest rates – in defiance of the wishes of politicians – so as to crush inflation, continued that the Fed “should not be asked to do too much, to undertake responsibilities that it cannot reasonably meet with the appropriately limited powers provided.”
That’s a nod to the Fed’s finite set of tools and the need for lawmakers to wield their powers to change taxation and spending, not just rely on monetary policy. Despite Bernanke’s urging years ago, Congress has yet to do much on this front since the crisis.
Steady economic and employment growth has obscured this inaction. But things may soon change. Since the Great Depression, the average length from the end of a recession to the beginning of a new one was just under five years. It has been more than eight years since the last downturn ended in June 2009. When the economy turns negative, Trump and legislators will no doubt target the Fed, both as the scapegoat and as a potential rescuer. The new chair will need a thick skin as well as an ability to play both defense and offense.
Set Yellen aside as a known quantity. As for Powell, he has not dramatically distanced himself from the chair he has served since 2012. In a June speech (bit.ly/2zsMmMG), however, he argued that an attempt by the House of Representatives to audit the Fed “risks inserting the Congress directly into monetary policy decision-making, reversing decades of deliberate effort by the Congress to insulate the Fed from political pressure.”
Taylor seems to agree, insisting in a 2016 speech (stanford.io/2hK1Q6V) that “de jure central bank independence is insufficient for generating good monetary policy.” His philosophical bent has been to push for a rules-based system for determining interest rates. The benefit, Taylor has argued, would be to limit the Fed's hand, thus making it even less susceptible to political influence or criticism.
Warsh, a colleague of Taylor’s at Stanford’s Hoover Institution, takes it a step further. “When the recession hits, we will have brought it upon ourselves. And the credibility that central banks and fiscal policymakers need to respond to recessions will also be hit during that same episode,” he told me during a Reuters Newsmaker panel last year.
Though it was before last November’s election, it sure sounds like appropriate scenario planning for the barrage of Trump tweets he can expect at the Fed.
On Twitter twitter.com/rob1cox
- President Donald Trump on Oct. 11 met with Stanford University economist John Taylor in his search for a new chair of the Federal Reserve, a White House official said.
- Trump was joined for the meeting by Vice President Mike Pence and members of his team helping in his search for a Fed chair, including Treasury Secretary Steve Mnuchin, the official told Reuters.
- Trump is working from a short list that includes Jerome Powell, a Fed governor, Kevin Warsh, a former Fed governor, his top economic adviser Gary Cohn, and current Fed Chair Janet Yellen, whose term expires in February, sources have said.
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