The Coming Fed Fight

TILBURG – There is no longer much doubt that Mitt Romney will be the Republican Party’s nominee to challenge President Barack Obama in the United States’ presidential election in November. If Romney wins, 2013 will most likely be Ben Bernanke’s last year as Chairman of the Federal Reserve.

Indeed, since the Republican primaries began, every candidate has indicated that Bernanke must go. Romney is no exception, claiming that Bernanke has overinflated the money supply, and saying that, “I’d be looking for somebody new.”

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Bernanke’s current term as Chairman will end at the beginning of 2014. While he could remain a board member until 2020, he would surely resign immediately if he were not re-appointed.

But, even if Romney wins the election and follows through on his pledge to replace Bernanke, he would still face a strongly Democratic Fed. Indeed, even if Romney served two terms as president, the Fed would lean to the left, because Obama has either appointed or re-appointed five of its Board of Governors’ seven members: Bernanke, who was re-appointed in 2009; Vice Chair Janet Yellen, the second most powerful board member, whose term ends in 2024; Daniel Tartullo, who will step down in 2022; Sarah Bloom Raskin, who will serve until January 2016; and Elizabeth Duke, whose term ended in January of this year, and whom Obama will likely nominate for a new 14-year term.

Obama’s legacy at the Fed can be compared to former US President George W. Bush’s judicial legacy. Bush had the opportunity to appoint not only two Supreme Court justices, but also an unprecedented number of judges in the lower federal courts. So, even with Bush gone for more than three years, Obama – and his prized health-care bill – must face a conservative Supreme Court.

If Obama wins a second term in the White House, his shaping of the Fed will go even further. First, he would have the option to keep or replace Bernanke. Moreover, he could re-appoint Raskin in 2016, meaning that she would serve until 2030. Add to that Yellen and Tartullo, as well as Jeremy Stein, who by then will be approved to serve until 2018, and Obama would shape the Fed’s policies for at least a decade. And, while the Federal Open Market Committee (FOMC), which sets US monetary policy, comprises not only the seven governors in Washington, but also five regional Federal Reserve presidents, the governors have the final say in choosing which five.

Moreover, there have been proposals to eliminate regional presidents from the FOMC, largely because they tend to be policy hawks – committed to keeping inflation low – while governors in Washington often prefer to focus policy on economic growth and employment, even if it places price stability at risk.

Historically, such political leanings have not had a great impact on policy outcomes, because overall economic health minimized challenges to orthodoxy. But that is likely to change, with slow growth making the governors’ influence on regional presidents more likely to affect monetary policy.

Indeed, this ideological divide is likely to become more defined in the coming years, as the independence of central banks around the world is threatened by new rules and regulations; as China – and, more generally, Asia – export inflation (reflected in US import prices); as protectionism rises, hitting free trade hard; and as new productivity-enhancing innovations, such as the Internet, remain absent. Moreover, rapid economic and population growth in emerging markets is already putting strong upward pressure on the prices of food, water, and commodities, while limits to supply persist.

Given this, the Fed will be the site of rising tension, as regional presidents counter the governors’ preference for monetary stimulus by pushing for policy tightening. Those tensions will surely weigh on US financial markets and, in turn, on the American economy and American politics.

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