The Next Fed Chair
Good central bankers make decisions based on what they believe is best for the economy, relying on evolving data, not on evolving political imperatives. Only two of the Trump administration's five apparent candidates to chair the US Federal Reserve fit the bill.
CAMBRIDGE – US President Donald Trump’s administration is expected, by November 2, to announce its choice, subject to Senate approval, to succeed Janet Yellen as Chair of the Federal Reserve Board in February 2018. The White House has indicated that it is weighing five potential candidates. Not all of them would be a good choice.
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The first candidate is Yellen herself. Though Yellen is a Democrat originally appointed by President Barack Obama, there is strong precedent for Trump to re-appoint her. Her three predecessors – Ben Bernanke, Alan Greenspan, and Paul Volcker – were each re-appointed to second terms by a president of the opposite party from the one who first appointed them, reflecting the value of continuity and predictability in central banking.
Yellen, whom I have known since we worked together in 1977, has performed very well in her nearly four years as Fed Chair. Though she hasn’t confronted a crisis, she did help to sustain the US economy’s steady recovery from the 2007-09 recession. Yellen, like Bernanke before her, used the Fed’s tools with a combination of clear communication and policy flexibility, shifting course as data revealed subtle changes in economic conditions.
The results speak for themselves. When Yellen was appointed to the Fed Board as Vice Chair in 2010, the US unemployment rate was at 9.9%. By the time she was promoted to Chair in 2014, it had fallen to 6.7%. Today, it stands at just 4.2% – and yet inflation remains low. Some complain that inflation remains below the 2% target; but the combination of low unemployment and low inflation used to be viewed as macroeconomic Nirvana.
The second potential candidate for Fed Chair is Jerome Powell, who has been on the Fed Board for five years. Powell might represent a good compromise for policymakers. On one hand, he has supported Yellen’s strategy, from her dovish interest-rate policies to her recent moves toward normalization. On the other, he is a longtime Republican with a financial background.
But Powell might face skepticism for his lack of academic training as an economist. PhD economists, like those who dominate the Fed’s staff and leadership, tend to favor their own kind and doubt others’ qualifications for top monetary-policy jobs. Certainly, a central banker without an economics PhD could struggle to hold his or her own against a large staff fluent in the models and jargon of academic economics.
Given this, many view a doctorate as a prerequisite for any Fed chair. But, in Powell’s case, I would argue that it should not be. Having known him since 1990, I can say that Powell has never been shy about asking questions. As a result, he has developed the analytical capabilities that a Fed governor needs. Almost as important, he won’t have a chip on his shoulder when dealing with more credentialed staff. From my perspective, Powell would stand out as one of the best appointments Trump has made.
The third potential candidate, Kevin Warsh, is a former Fed governor, who also has a background in finance – in this case, at Morgan Stanley – rather than in academic economics. But that is where the similarity between him and Powell ends.
Warsh, like many Republicans, has harshly criticized the Fed’s attempts to stimulate the US economy in the aftermath of the global financial crisis, warning that the unprecedented expansion of the monetary base brought about by quantitative easing would trigger high inflation. Warsh started making such hawkish – and clearly incorrect – warnings in 2010, when unemployment was 9.5% and runaway inflation was the last thing most economists were worried about. One can’t help but wonder if Warsh understands how the economy works.
The same cannot credibly be asked about the fourth candidate, John Taylor. Like Yellen, Taylor is an eminent economist with an impressive record both in academic research and as a practitioner of macroeconomic policy. In fact, he is the sixth most widely cited monetary economist, owing his renown especially to the Taylor rule, a guideline for setting interest rates in response to observed inflation and growth.
Nonetheless, like Warsh, Taylor has long believed that monetary conditions are excessively generous. That criticism was probably warranted during the housing boom that resulted in the 2007-09 financial crisis. And Taylor was in an ideal position to deliver that message, because he served as Under Secretary of the Treasury for International Affairs until 2005, which means that he met regularly with Greenspan, then the Fed’s chair, in private. One wonders why, if he is so opposed to easy monetary policy, he didn’t convey that to Fed governors at a time when the message might have done some good.
The White House’s final potential pick, Gary Cohn, is currently the director of Trump’s National Economic Council. But Cohn, who has no background whatsoever in monetary economics and whose views are unknown, may already be out of the running.
The complaint of most Republican leaders since Obama took office in 2009 is that monetary policy has been too loose. (Trump said the same when he was campaigning for the presidency, though, once in office, he suddenly proclaimed himself a “low rates guy.”) House Republicans wanted the Fed to adopt Taylor-style rules then; now, they want Trump to appoint Taylor himself.
But, historically, Republicans have pushed easy monetary policy when they have had the presidency. If, as is likely, financial markets and the economy run into headwinds in the medium term – perhaps in the run-up to the next presidential election – Trump will almost certainly blame his troubles on the Fed. The complaint, however, will not be that monetary policy is too easy, but that it is too tight.
Good central bankers wouldn’t heed such politicized criticism either way. They would make decisions based on what they believe is best for the economy, relying on evolving data, not on evolving political imperatives. The sitting governors have demonstrated the ability to do that.