By Brenda Wenning
The U.S. Supreme Court isn’t the only influential government entity that President Trump will have an opportunity to make his mark on.
The Federal Reserve Board will likewise bear the Trump brand in the not-too-distant future. Two of the seven seats on the Federal Reserve Board of Governors are already vacant and now a third governor, Daniel K. Tarullo, has announced that he will step down in April. Called the “lead architect of post-crisis financial regulations plans” by The Wall Street Journal, Tarullo is not likely to be replaced by a pro-regulation governor.
In addition, the Fed’s influential general counsel Scott Alvarez, who has sometimes been referred to as “the eighth governor,” will retire this year after a 36-year career at the central bank. And the leadership term of Chair Janet Yellen expires in January 2018, while Vice Chair Stanley Fischer’s term expires in June.
The changes are likely to result in a different perspective for the board, which has been dominated by “academics who don’t know how finance and the economy really work,” according to Danielle DiMartino Booth, a former Federal Reserve Bank of Dallas staffer and author of a new book, Fed Up: An Insider’s Take on Why the Federal Reserve Is Bad for America.
Booth describes “a tribe of slow-moving Fed economists who dismiss those without high-level academic credentials,” and she counts Ms. Yellen and predecessor Ben Bernanke among them.
“Central bankers have invited politicians to abdicate leadership authority to an inbred society of Ph.D. academics who are infected to their core with groupthink, or as I prefer to think of it: ‘groupstink.’”
We hope the final copy offers more wit and insight than that, but you likely get the idea.
Yellen Going Neutral?
Even putting aside these personnel moves, changes are afoot at the Federal Reserve Board. Ms. Yellen, who has carried on the zero interest rate policy (ZIRP) of her predecessor throughout her term, has been talking about a “neutral interest rate.”
The “neutral interest rate,” also known as r star or r* (I couldn’t make this up), is being floated as a new concept (see macroprudential supervision), but it’s pretty much what Swedish economist Knut Wicksell called the “natural rate” back in the pre-Fed late 19th century, when he imagined an interest rate that would exist in a world without central banks. (While it’s good to see his concept of a natural interest rate become popular, we find his fantasy about a world without central banks to be even more appealing.)
As The Wall Street Journal reported, Ms. Yellen mentioned the neutral rate three times in a single key paragraph in her recent semi-annual Congressional testimony, so it’s clear that “this almost 120-year-old idea is the new new thing.”
The perceived move from the supernatural Bernanke era to the unnatural early Yellen era and now the natural interest rate era could just be wishful thinking on the part of conservatives and other non-Keynesians who recognize that when the Fed wings it with ZIRP, forward guidance and other monetary malarkey, we all pay. After all, conjecture about a natural-neutral-r* star rate was taking place as early as June.
However, Ms. Yellen had not previously mentioned the concept in Congressional testimony, so she must be serious about it. During her testimony, she sounded like Goldilocks, as she described the neutral rate as “the interest rate that is neither expansionary nor contractionary” (but “just right,” we presume).
“Now that inflation is back near 2%,” The Journal noted, “Wicksell would smile upon the Fed’s slow rate increases and its plan for continued gradualism. This approach means that if Mr. Trump manages to make the American economy great again, the Fed won’t kill the expansion by tightening. Seen in the context of the natural-rate rule, these gradual increases wouldn’t be tightening at all. The Fed would merely be tracking the natural rate higher as the economy shifted to a faster-growth footing.”
It will be interesting to watch just how gradual rate hikes will take place. While Ms. Yellen told Congress, “waiting too long to remove accommodation would be unwise, potentially requiring the FOMC (Federal Open Market Committee) to eventually raise rates rapidly, which could risk disrupting financial markets and pushing the economy into recession.”
And it will be even more interesting to watch the Fed boost rates while President Trump seeks to weaken the dollar to gain more trade leverage.
Who Has the Power Now?
You may be thinking that a natural rate is a natural idea, in line with a rules-based policy that would restrain the Fed’s activist instincts, which many blame for everything from the 2007-2008 financial crisis to the current slow-growth era. What’s not to like?
Remember, though, that the Fed makes its own policy. And adopting a neutral rate, according to The Journal “would, in the end, effectively reduce the Fed from an all-powerful economic meddler to a mere clearing house for banking-system reserves.”
While that may be a good thing for all of America, it’s not necessarily a good thing if you’re a Fed chair or board member. In a city where power equals status, once the rate becomes neutral, the Fed would be neutered.
Conversely, Ms. Yellen may be thinking that being Fed chair isn’t such a bad gig and if she wants to keep her job, she needs to do her bit to make America great again. After all, if she doesn’t do it, someone else will.
And someone else may anyway. Given the number of appointments President Trump will have an opportunity to make at the Fed, he, not Ms. Yellen, truly holds the power and, as The Journal notes, “Mr. Trump could end a century of dangerous improvisation by a central bank with seemingly unlimited power over the economy.”
May he use his power wisely.
Brenda P. Wenning is president of Wenning Investments, LLC of Newton, Mass. She can be reached at [email protected] or 617-965-0680. For additional information, visit her blog at www.WenningAdvice.com.