Update 217: Trump’s Expected Fed Chair Pick Seen Likely More Establishment than Bannonist

This Thursday, President Trump is expected to nominate the next Federal Reserve Chair.  After months of speculation, the prohibitive favorite at this hour is current Fed Governor Jay Powell.  But Trump enjoys the elements of suspense and surprise and has thrust the nomination into the public forum, even conducting an informal poll of Senate Republicans at a conference lunch.

Will he decide at the last minute to nominate hawks Warsh or Taylor… or will he stay the course with Yellen?   Below we examine the key policy implications of each potential Fed Chair and the considerations that may bear on the candidate’s Senate confirmation vote.

Best,

Dana

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Implications for Monetary Policy

•  Interest Rate Policy

Powell:  Powell presents a “centrist” approach to monetary policy.  As a Fed governor, he often voted with the board to maintain a near-zero interest rate environment in order to aid recovery efforts.  A close colleague of the current Chair, Janet Yellen, Powell would maintain the current policy course of gradual rate hikes to sustain steady economic expansion and falling unemployment.

Warsh:  Warsh’s limited experience as a Fed Governor from 2006 to 2011 provides little certainly regarding in his monetary policy expertise.  While serving on the board, Warsh wildly overestimated the risk of inflation, which teetered at a mere two percent at the time. As Fed Chair, he is expected to aim for higher interest rates than what is presently expected from current Fed policies.

Taylor:  Taylor’s candidacy incites fear in investors. His blatant promotion of the eponymous Taylor Rule, which dictates where the federal funds rate should be considering prevailing conditions, would increase the current rate to slightly over three percent. Economists and market analysts alike are skeptical about whether the economy is ready for such a change in direction.

Yellen:  Yellen’s experience and consistency in monetary policy has produced undeniable economic success.  She is expected to continue present policies if reappointed.  Her strategy would follow the course of gradual, inflation-dependent interest rate increases.

•  Pursuit of the Neutral Rate

The neutral rate is the rate at which the GDP grows at the optimal rate while maintaining stable inflation. The Fed recently reduced its expectation of the neutral rate from 3 percent to 2.75 percent. This is a historical low for the estimate, but given the slow recovery of the economy, the figure is reasonable.

Each candidate has a specific view of what the neutral rate should be. Candidates like Yellen and Powell are in sync on holding the neutral interest rate at 2.75 percent before inflation. Taylor and Warsh stand on the opposite side of the debate. Warsh claims this rate should be higher than the Fed’s projection and Taylor’s Rule would put this rate at 3.13 percent before inflation.

Implications for Fed Asset Selling Program

Reducing the Treasury’s balance sheet is one of the largest items on the agenda for the next Fed Chair. Most of the candidates would accelerate the normalization process.  By selling off Treasury holdings, the Fed would inject securities into the economy and steadily push the interest rate upwards.

Yellen is committed to a slow and steady normalization regimen. Powell, who voted in support of quantitative easing a few years ago, supports a faster rate of normalization than Chair Yellen. Taylor and Warsh would accelerate the normalization process. Taylor’s belief in a less-interventionist Fed suggests he will pursue relatively rapid normalization efforts. Warsh holds a similar view. He disagreed substantially with the Fed’s second round of bond-buying in 2011.

Implications for Regulatory Policy

The Dodd Frank Act has been under attack since the Administration took over, but at the Fed, Yellen has been stalwart in maintaining the authority and practices implemented since the crash.  Each candidate in contention to replace her may soften these protections to varying degrees.

Powell, the odds-on favorite, would be the next best protector of Dodd Frank.  However, he believes some DFA provisions are unnecessarily burdensome and are inappropriately applied to small and medium sized banks.

Taylor comes next in terms of deregulatory tendencies.  Though Taylor is more vocal and better-known for his monetary policy preferences regarding the interest rate, he has made it clear he believes firms are micromanaged post-crisis and would take steps to loosen the protections Dodd Frank put in place for banks of all sizes.

Warsh is the true embodiment of the deregulatory impulse. During the financial crisis, he was a strident critic of Chairs Bernanke and Yellen’s balance sheet policies.  He has maintained his pre-crisis stance on deregulating Wall Street. Democrats would vehemently oppose a Warsh nomination to preserve the Dodd Frank Act’s progress.

Political Factors and Senate Confirmation

After the President makes his announcement, the candidate will go before a Senate eager to weigh in.

Powell:  Powell received two separate confirmations for a seat on the Board of Governors in 2012 and 2014. In 2014, he was confirmed with no Democratic Nay’s and ten Yea’s from Republicans still in the Senate. Powell’s centrism raises concerns among some Republican Senators. Senator Scott said that Powell would have to “answer serious concerns both old and new at any potential nomination hearing”. His previous confirmation will muddy the waters for both Democrats and Republicans looking to change their votes, and the confirmation hearings will certainly be intense if he is nominated.

Warsh:  In 2006 Warsh was confirmed to be a Federal Reserve Board Governor by a voice vote. At 35, there was significant concern that he was too young and inexperienced for the role. 11 years later he would still be a toxic pick in the eyes of Senate Democrats and potentially more than a few Republicans. He has no academic background in economics, missed the mark with many of his predictions during the ‘08 crisis, and appears to be an active Republican fundraiser. He would be both a dangerous pick and difficult confirmation.

Taylor:  Taylor was confirmed by the Senate in 2001 to be Treasury undersecretary in the Bush administration.  He passed via voice vote and is seen as a politically vanilla academic.  While his policies provide cause for concern for Democrats as mentioned above, he would likely receive the needed majority from the right. Choosing Taylor would be a win for those who wish to constrain the Fed’s intervention, despite the likelihood Taylor would raise rates.

Yellen:  Janet Yellen was confirmed by the Senate in 2014 with 56 Yea’s and 26 Nay’s.  All Nay’s were Republican, 23 of whom still serve.  Yellen received broad Democratic support and four Yea’s from Republicans who still serve. She is the near consensus choice for academic and Wall Street economists and Yellen would be the most palatable option for Democrats. This latter point would make her renomination a difficult pill to swallow for Senate Republicans — not only do many of them disagree with her on policy grounds but four more years of a Yellen-led Fed would be perceived as a Democratic win.