With Trump in Power, the Fed Gets Ready for a Reckoning

[MikeWB]

WASHINGTON — Paul A. Volcker, the Federal Reserve chairman, received an urgent warning two weeks after Ronald Reagan won the 1980 presidential election. Some of the president-elect's advisers, he was told, wanted to abolish the central bank and replace it with a computer program that would manage interest rates and monetary policy.

Today, a Democratic Fed leader is once again bracing to see whether victorious and emboldened Republicans will try to overhaul the central bank.

In almost three years as the Fed's chairwoman, Janet L. Yellen has led an aggressive campaign to stimulate economic growth. Donald J. Trump, the president-elect, has embraced criticism that the Fed is causing more problems than it is solving, and he has surrounded himself with advisers who would like to rein in the institution that has the greatest influence over the direction of the nation's economy.

Mr. Trump can fill a majority of the Fed's seven-member board with his own nominees over the next 18 months, including replacing Ms. Yellen in February 2018. He also could work with Congress on new constraints, including some form of an old idea on the right that a formula should dictate the Fed's movements of interest rates.

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Or Mr. Trump could emulate Mr. Reagan and leave the central bank alone.

When the two men finally met, Mr. Reagan asked Mr. Volcker why the country needed a central bank. He apparently found the answer convincing. Like other presidents in recent decades, he decided the Fed was reasonably effective and useful as a scapegoat. And in 1983, he nominated Mr. Volcker for a second term.

Mr. Trump's intentions are unclear in part because there is a tension between his personal preferences and his political commitments. He is a borrower who now heads the political party that has long represented the interests of lenders.

Mr. Trump has described himself as "a low-interest-rate person," reflecting his background as a real estate investor who drew heavily on other people's money. He also has promised to deliver stronger economic growth, a goal that could be inhibited by higher interest rates. Politicians — their careers dependent on short-term economic performance — generally favor low rates, even at the expense of future inflation. That is the very reason the Fed is insulated from political pressure.

Many of the advisers surrounding Mr. Trump, however, have long advocated that the Fed focus on controlling inflation, even at the expense of short-term growth. They have argued that the Fed has little power to increase economic activity beyond Wall Street — and on Wall Street, they warn, the Fed is encouraging excessive speculation.

Over the course of the campaign, Mr. Trump increasingly echoed those views. In early September, he said the Fed was supporting a "very false economy" by driving asset prices to what he described as unsustainable heights. "We are in a big, fat, ugly bubble," Mr. Trump said during the first presidential debate, a few weeks later.

It may be surprisingly easy, however, for Mr. Trump and Ms. Yellen to find common ground. Like Mr. Reagan before him, Mr. Trump has promised tax cuts and increased spending on infrastructure and the military, which could provide a large dose of fiscal stimulus. If the economy starts growing quickly, it would be easier for the Fed to raise rates.

Financial markets climbed last week, reflecting optimism among investors that single-party control of government will lead to faster growth. Both parties wanted to take steps to encourage faster economic growth and more jobs. Republicans will now get to do it their way.

After the election, it was widely predicted that markets would crash — and that the Fed would back away from increasing rates in December. So far, those predictions have failed to materialize. The odds of a December increase, as implied by asset prices, stood at 76 percent on Friday.

Ms. Yellen and other Fed officials have called repeatedly in recent years for a healthy dose of fiscal stimulus, and it seems likely they would greet faster growth with relief.

"It certainly breaks gridlock in Washington, which has been a key complaint of how the economy has operated," James Bullard, president of the St. Louis Fed, told reporters on Thursday. And Charles Evans, president of the Chicago Fed, said the prospect of increased infrastructure spending was "good news."

Moreover, there are signs Mr. Trump would like to focus on fiscal policy and leave the Fed to its devices. David Malpass, who is leading Mr. Trump's economic transition team, said in an email that there had been too much focus on the direction of monetary policy. "There should be focus on growth-oriented structural reforms including reforms of taxes, trade, regulatory policy and energy policy," he said.



Other advisers to Mr. Trump also emphasize that his goal is to drive economic growth through changes in fiscal policy, easing the burden on the central bank.

"We're a little obsessed with the Fed, and that's part of the problem," said Judy Shelton, director of the Sound Money Project at the conservative Atlas Network and a member of Mr. Trump's economic advisory group. "Instead of people looking to the Fed to be planning things, it should be in the background, providing a solid foundation of monetary integrity for real economic and entrepreneurial activity."

Mr. Trump could quickly overhaul the Fed's leadership. Ms. Yellen's four-year term as Fed chairwoman ends on Feb. 3, 2018. Stanley Fischer's four-year term as the Fed's vice chairman ends a few months later, on June 12, 2018.

Mr. Trump also can move immediately to fill two open seats on the Fed's seven-member board. Senate Republicans have refused to consider President Obama's nominees for those vacancies. In effect, that means Mr. Trump's nominees could control a majority of the board well before the 2018 midterm elections. The seven Washington-based board members hold a majority of the decision-making power on a larger group, known as the Federal Open Market Committee, that sets monetary policy.

"A core view of many Trump advisers is that the extended period of emergency policy settings has promoted a bubble in the stock market, depressed the incomes of savers, scared the public and encouraged capital misallocation," said Ian Shepherdson, chief economist at Pantheon Macroeconomics. "Right now, these are minority views on the F.O.M.C., but Trump appointees are likely to shift the needle."

Other observers, however, are less certain that Mr. Trump will want to hit the brakes. Mr. Shepherdson acknowledged that it was "unusual" for politicians to push for higher interest rates. And Joseph Gagnon, a former Fed economist and a fellow at the Peterson Institute on International Economics, said Mr. Trump's own statements suggested he might decide he likes what the Fed is doing. "It's going to be Trump against his advisers, or against the Republicans in Congress," he said.

Presidents in recent decades also have sometimes backed away from replacing the Fed's leadership, because transitions can roil financial markets. President Clinton twice reappointed the Republican Alan Greenspan. In 2010, President Obama reappointed Ben S. Bernanke, first nominated by President George W. Bush, before naming Ms. Yellen in 2014.

But Mr. Trump said in May he would "most likely" replace Ms. Yellen. "She is not a Republican," he said in an interview with CNBC. He also has attacked her personally, declaring in September, "I think she should be ashamed of herself."

If Ms. Yellen is replaced at the end of her first term, she will have served the shortest stint as the Fed leader since G. William Miller came and went quickly in the 1970s.

Congressional Republicans also are likely to renew their calls for changes in the Fed's operating instructions. They have repeatedly criticized the Fed's monetary policy in recent years as opaque, inconsistent and misguided, and they have advanced a number of proposals to constrain it.

"It is way past time for the Fed to commit to a credible, verifiable monetary policy rule, to systematically shrink its balance sheet and get out of the business of picking winners and losers in credit markets," Representative Jeb Hensarling, the Texas Republican who is chairman of the House Financial Services Committee, said at a hearing in June.

Last year, Mr. Hensarling's committee passed legislation requiring the Fed to describe a rule for moving interest rates and to justify any deviations from that rule.

Another proposal would subject the Fed's decisions to a regular external review.

And some Republicans may now be emboldened to pursue larger changes that would impose even tighter constraints on the movement of interest rates. Some conservatives have long favored the restoration of a gold standard — a system in which the value of the dollar is determined by the price of gold, limiting the Fed's ability to print money and, in theory, constraining inflation. The idea of a monetary policy computer program was advanced by the economist Milton Friedman as an improvement on the gold standard, allowing steady growth in the money supply.

Mr. Trump ruminated on the merits of a gold standard in a campaign interview with TheScene.com this year. "Bringing back the gold standard would be very hard to do, but, boy, would it be wonderful," he said. "We'd have a standard on which to base our money." But there is no sign such reforms number among his priorities.

Fed officials have strongly opposed any increase in congressional oversight, describing such measures as infringements on the Fed's operational independence that might interfere with the central bank's ability to promote growth.

Mr. Gagnon said they might come to regret not having embraced modest reforms.

"I have thought that all the proposals so far are not as horrendous as people at the Fed seem to think they are," he said. "Now there could be more proposals."

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