The following is about Donald Trump in only one respect: He has an unprecedented opportunity to remake the Federal Reserve.
As active as he has been since the election, neither he nor his staffers has said a word about the Fed, neither policies nor people. During the election he let fly one critical line about Chair Janet Yellen, but that’s been it.
What could change?
The possibility of change flows from the Fed’s 105-year-old structure — and, of course, Republican control of Congress and the White House.
The Fed’s leadership has always been seven governors, appointed by the President and confirmed by the Senate, each to 14-year terms staggered in even-numbered years — and rarely served fully (the pay is awful relative to responsibility and time — $179,900 per year).
One of the governors is appointed Chair by the President and confirmed by the President; the Chair’s term is only four years, commencing one year after each Presidential election.
Another, far weaker power center at the Fed: the 12 regional Fed banks each has a president selected by local boards of directors.
Fed interest-rate decisions are made by the Fed Open Market Committee (FOMC). All seven governors have a vote, as does the New York Fed president, and three of the other eleven regional presidents rotate as voters.
Chair Yellen’s term is up next February (though she will continue to be a governor if she wishes) and Vice Chair Fischer’s in June.
Two governor seats are empty now, and a third will open this summer (Tarullo has announced his retirement). Thus, Mr. Trump may immediately appoint three new governors, and announce new Chair and Vice Chair intentions in little more than six months.
What change might look like
Change at the Fed will follow the following trails:
1. Mostly on the political right, though not always, a significant minority in Congress has objected to the Fed’s independence. Congress created the Fed (the concept of “central banking” dates to 1875 in England, hence not a word in our constitution) and can change the Fed any way it wishes.
The Fed’s independence has survived mostly because Congress and the public understand that we can’t be trusted with money.
2. Those who would trim Fed independence point to its mistakes: It failed to react to the Great Depression; and it did not prevent either the late 1990s stock bubble or the early 2000s credit bubble.
Many object to the hyperactive Fed, 2008-present, critics saying that it exceeded its authority and was ineffective.
Dodd-Frank added to Fed power, making it the overall regulator of credit and risk in the banking system.
3. The means of limiting Fed power usually involves forcing mechanical, “rule-based” decision-making onto the Fed and removing its discretion. Dodd-Frank has many enemies.
4. Most who would limit the Fed want to reduce its profile and impact on markets and want the Fed immediately to “normalize” its interest rate — the overnight cost of money known as the “Fed funds rate” — meaning to raise quickly from 0.75 percent today to 3 percent or more.
This “normalization” would be a far more restrictive policy than the one embraced by the current Fed.
5. The Fed and its staff (the largest collection of economists in the world) believe the U.S. economy is growing as fast as it can without igniting inflation — GDP (gross domestic product) growth about 2 percent per year, the unemployment rate now about as low as possible.
The Fed may be mistaken and, in any event, is at cross-purposes with the Trump administration’s desire (as well as others) for growth in the 3 percent to 4 percent range.
Current Fed theory and policy would accelerate rate hikes in order to prevent “overheating” on that scale.
You can see the difficulties. Having never had a rule-based Fed, we have no tested rule to install. An inert Fed would give more freedom of action to markets, which would bring its own rewards and risks.
New Fed leadership could try to accommodate faster growth, but if inflation began, then a new recession would follow quickly.
The outcome of new decisions about the Fed may well have more impact on the economy, present and future, than the sum of all economic change brought by the new administration.
(Note: I am a believer in the Fed as it has operated. I have my gripes with Mr. Greenspan and Mr. Volcker, but nothing but praise for Mr. Bernanke and Ms. Yellen. Nevertheless, I have tried to articulate the choices ahead without any derision for those who disagree.)
Lou Barnes is a mortgage broker based in Boulder, Colorado. He can be reached at lbarnes@pmglending.com.
