Powell, Taylor lead charge to head the Fed

After an early opportunity to stamp his political base’s social views on the Supreme Court, President Trump has the historically rare chance to remake the Federal Reserve’s seven-seat Board of Governors.

The president is about to announce his nominee for the position of Fed chair, currently held by Janet Yellen, a highly regarded economist and top-performing chair by historical standards. Who will President Trump appoint, and what will be the consequences for U.S. monetary and regulatory policy?

{mosads}Predictit, a popular betting site watched by the markets, has sitting Fed Governor Jerome Powell confirmed as chair by February 2018 at about 50-60 percent, up from 40 percent just a few days ago. John Taylor of Stanford University is behind him with a 20-25 percent chance.

All other contenders lag more significantly, including Yellen, who as incumbent, should be the frontrunner, and Gary Cohn, who was everybody’s best bet until he broke the president’s trust with critical remarks in the wake of the Charlottesville events over the summer. 

Jerome Powell is the most likely winner for a few good reasons: First and foremost, he would not choke the president’s economic agenda by advocating for aggressive monetary-policy tightening if the tax cuts were to be approved and blow up the budget deficit, as Gavyn Davies recently noted.

He would work well with the newly appointed governors — Vice Chair of Supervision Randal Quarles, who will oversee the U.S. banking system, and Joseph Otting — in rolling back some of the crisis-era regulations. He is acceptable to Republicans in the Senate, and he would represent needed and valued continuity.

John Taylor would make an ideal No. 2 in command. His views on regulation are less known than those on monetary policy and are more singular. Taylor would like to see monetary policy set on autopilot following his famous rule, while keeping regulation a bit tighter than before the crisis, but constant over time.

This would justify rolling back some of the Fed’s involvement in the financial system since the subprime crisis, without triggering a public outcry like after so many of Trump’s other nominations. He would also bring to the job the credibility that a well-respected academic typically carries to Washington, D.C.

Will a Fed led by Powell and Taylor reshape U.S. monetary and regulatory policy in Trump’s own image? No! They will largely continue with business as usual, with incremental, rather than radical, changes.

Unlike the Supreme Court, which deliberates on issues of an ethical nature and must interpret the law from a subjective perspective, the Fed is an institution driven by relentless fact-searching, analysis and evidence-based discussions.

The hundreds of Ph.D.-trained economists in the system operate in osmosis with the broader academic community. New ideas emerge and are adopted in a gradual process of learning and fine tuning that takes place well beyond the board’s conference room. An attempt to impose radical, untested approaches to the conduct of monetary and regulatory policy would not pass this filter.

The big, new thing that academia came up with in monetary policy after the crisis was the so-called “macroprudential regulation.” This new policy calls for using a variety of regulatory tools to cool the financial cycle when it is too hot and to support it in times of distress.

In theory, these additional tools would help attain even better economic outcomes than following simpler rules, like the one favored by Taylor that focuses only on output and inflation.

But adding macroprudential policy to the Fed’s arsenal would require intervening in specific financial markets, without fully understanding the consequences and the risks of such actions. No wonder, therefore, this was not appealing to the outgoing Fed leadership, nor will it catch on with the likely Powell-Taylor duo.

Powell and Taylor will continue to grapple with the same issues faced by Janet Yellen and Stan Fisher, the former vice chair. The most difficult and pressing of which is the disconnect between the degree of resource utilization in the economy and the behavior of consumer price inflation, which would make it hard to use Taylor’s rule.

Also, there is a disconnect between bond and equity yields on which the assessment as to whether we have a bubble in the equity market rests. Finally, there is the more recent disconnect between political uncertainty and financial market volatility.

As Vincent Reinhart, a former senior Fed official, recently noted, the solution to these puzzles lies in understanding why the U.S. economy is not catching up to its pre-crisis potential rate of growth. This, in turn, has to do with why all the technological advances and financial engineering we access are not translating in higher productivity; something the Fed, like everybody else, has no clue about. 

A cautious chairperson, accustomed to the Fed decision-making process but open-minded enough not to be wedded to any particular view of the economy, along with an opinionated vice chair will make a duo that can be sold to the president’s political base.

It will certainly not do harm to the economy and, if academia comes up with the next real big thing, could actually help improve U.S. monetary and regulatory policy.

Alessandro Rebucci is an associate professor at Johns Hopkins’ Carey Business School, who holds a joint appointment with the economics department of the Kriger School of Art and Science. Previously he held research and policy positions at the International Monetary Fund (1998-2008) and the Inter-American Development Bank (2008-2013).