Today, we present a guest post written by Jeffrey Frankel, Harpel Professor at Harvard’s Kennedy School of Government, and formerly a member of the White House Council of Economic Advisers. A shorter version appeared in Project Syndicate.
The Trump Administration has said it will announce its choice for the new Chair of the Federal Reserve Board before November 3rd. Subject to Senate confirmation, the chosen candidate will succeed Janet Yellen, whose term ends February 3.
The Trump White House has said it views five candidates as front runners. Two are eminent economists with unusually impressive records both in academic research, mostly at West Coast universities, and as practitioners of macroeconomic policy. That would be Yellen herself, who is a strong candidate for reappointment, and Stanford’s John Taylor. The other three front-runners are not professionally trained as economists, but rather come from financial backgrounds: Gary Cohn, Jerome Powell, and Kevin Warsh. They worked, respectively, for Goldman Sachs, Dillon Read, and Morgan Stanley; all three also have important government experience.
Consider first the two who are incumbent Fed Governors.
Although Janet Yellen is a Democrat originally appointed by President Obama, there is good historical 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 presidents of the opposite party from the president who had first appointed them. There are great virtues to continuity and predictability.
Yellen has done an excellent job in her four years as Fed Chair. (Full disclosure: I have known her since 1977. Also she was Chair of Bill Clinton’s Council of Economic Advisers when I was one of the other two Members.) Although she has not had to deal with the onset of a crisis, she has successfully presided over a continuation of the steady recovery of the economy after the great recession of 2007-09. Of course monetary policy is not the only determinant of national economic performance, especially under conditions as prevailed after 2008. (Under these conditions, fiscal policy would be a far more powerful tool than monetary policy, if the politicians could ever get their act together to apply tax and spending policy counter-cyclically rather than pro-cyclically.) But there are important things that the Fed could do even when interest rates were at or near the zero lower bound, and the Fed did them under Chairs Bernanke and Yellen.
Yellen has managed to combine clarity of communication, to audiences at all levels, with flexibility of policy, appropriately shifting course as real-time data show subtly changing economic conditions. It is a challenge to combine these two skills, as transparency can call for forward guidance or commitments to rules that later events require abandoning. Accordingly she and her Fed colleagues deserve a good share of the credit for the long economic expansion.
The unemployment rate was 9.9% when Yellen was appointed to the Fed Board as Vice Chair in 2010 and 6.7% when she was promoted to Chair in 2014, but has now declined to 4.2%. And yet inflation has not reignited. This combination of low unemployment and low inflation used to be viewed as macroeconomic Nirvana.
Many recent commentators have spoken as if the failure of inflation to climb to 2 per cent or higher is a major problem. But I do not see it that way. The Fed has done well to steer the economy to full employment. (And populists are wrong if they think that low interest rates are bad for income distribution.) The difference between 1 ½ % and 2 % inflation, which some see as so large, looks to me small enough to be a temporary aberration or even measurement error.
Jay Powell, who has been on the Board for five years, could be a natural compromise candidate. On the one hand he has supported Yellen’s strategy, generally considered to have been dovish. On the other hand he comes from the financial markets and is a long-time Republican. These traits should obviate opposition from Congressional Republicans, many of whom unprecedentedly voted against Ben Bernanke’s confirmation for a second term in January 2010 — scandalous in light of his professional qualifications and puzzling in light of his history (a native of South Carolina who was chairman of George W. Bush’s Council of Economic Advisers).
PhD economists tend to know and like their own kind, and to have doubts about the qualifications of others for top monetary jobs. Indeed economics PhDs overwhelmingly dominate both the staff and the leadership at the Fed. Doctorates among district presidents have gone from very rare 70 years ago to an overwhelming majority today, and have in recent decades become increasingly perceived as a requirement for the Chair position. The trend is equally widespread in other countries. A central banker without an economics PhD could have trouble holding his own against a large technically-trained staff fluent in the formidable models and jargon of academic economics.
It should go without saying that some brilliant ivory tower academics do not possess the other personal characteristics necessary to do well in major leadership or managerial positions. But even if a PhD is not a sufficient condition for Fed Chair, is it a necessary one?
I may be one of the few academic economists who has had the good fortune of having known Jay Powell since 1990. So let me offer some testimony. Powell has never been one of those so prevalent in government or the private sector – or, indeed, academics — who “doesn’t know what he doesn’t know.” That is, he has no hang-up about admitting when he has questions about something. As a result Powell mastered the analytical side of what he needed to know as Fed Governor. Almost as important, he won’t have a “chip on his shoulder” in dealing with the PhD-holding staff. He would be one of the best appointments Trump has made.
Powell is generally considered another dove, because as Fed Governor he has voted to support Yellen’s low interest-rate policies (though he has also supported the recent movements toward normalization of interest rates).
Many Republicans have been harshly critical of the Fed’s attempts to stimulate the US economy into recovery from the 2007-09 recession, warning that the unprecedented expansion of the monetary base. which was an admittedly eye-catching aspect of Quantitative Easing would lead to high inflation. Remember when Texas Governor Rick Perry threatened Ben Bernanke (“we would treat him pretty ugly down in Texas”) for monetary stimulus in 2011 at a time when unemployment was still 9.0%. These warnings go back even to the bottom of the recession, when excess capacity in the economy signaled to most economists that inflation was the last thing to worry about. Warsh has been saying such hawkish things since 2010, when unemployment was 9 ½ %. One can’t help but wonder if he understands how the economy works.
One can’t credibly say that John Taylor doesn’t understand how the economy works. Among monetary economists, he is the 6th most widely cited. [Citations counts are the way academics like to quantify their reputations. Ben Bernanke ranks as #1 among monetary economists.]. He is super-famous for the Taylor rule, a guideline for setting interest rates in response to observed inflation and growth. But even before that he made many other important contributions to macroeconomics, such as a theory of overlapping contracts that helped reconcile rational expectations theory and sticky-price reality.
Taylor, like Warsh, criticizes monetary policy for being too easy, which is presumably why the Wall Street Journal recently endorsed the two of them. This criticism of the Fed is more merited in the case of Alan Greenspan’s permissiveness in the period of the housing boom, before the 2007-09 mortgage crisis. But up to 2005 Taylor held the position of Under Secretary of Treasury for International Affairs in the Bush Administration, and so met regularly with the Fed chair in private. One wonders why he didn’t convey to the governors then (in private) the view that monetary stimulus in 2003-04 was overdone.
Gary Cohn, currently director of Trump’s National Economic Council, has no background in monetary economics, neither in terms of technical training nor experience as a practitioner. His views on monetary policy are unknown. On financial regulation he is Trumpian in having decided that government has been too mean to the banks in the aftermath of the financial crisis. In any case, he may already be out of the running.
- Monetary hawks and doves
The complaint of most Republican leaders since Obama took office in 2009 has been that money has been too easy (emphatically including Trump when he was campaigning for the presidency, before he took office in January and suddenly proclaimed himself a “low rates guy” even though the economy had reached full employment). Congressional Republicans wanted the adoption of Taylor-style rules to rein in the Fed. Many of them are still pushing the Obama-era complaint and it is on these grounds they now urge Trump to appoint John Taylor.
The historical pattern is that Republicans push easy monetary policy when they have the presidency, even “true conservatives” like Nixon and Reagan. It is predictable that sometime in the future, perhaps in the run-up to the next presidential election, the financial markets and the economy will run into some rougher weather and the President will blame his troubles on the Fed. The complaint at that time will not be that monetary policy is too easy but that it is too tight.
But good central bank officials make decisions based on what is likely to be best for the economy, based on the evolving data, not based on what suits the evolving political needs of the party in power. The sitting governors have demonstrated the ability to do that.
- Vice Chair
There has been natural speculation that Trump could pick one of the five candidates to be chair and another to be Vice-chair, a position which sadly Stanley Fischer is now vacating. Most assume that neither Yellen nor Warsh would dream of accepting the number two position. Conventional wisdom is that no self-respecting Washington official would settle for a job of rank equal to lower to the position previously held. I have never quite understood this logic. The argument seems to be “if I can’t be the most powerful person, then I’d rather have no power at all than settle for the #2 slot.”
Historically not all Washington officials have obeyed the conventional wisdom. John Quincy Adams had a long successful career as a Congressman, after failing to achieve a second term as president. William Howard Taft too was happier serving as Supreme Court Chief Justice than he had previously been in the White House. Setting a worthy example, Fischer accepted the #2 job at the Fed in 2014 even though his abilities and experience would have qualified him to be Chair.
This post written by Jeffrey Frankel.