To no one’s surprise, Chair Yellen has announced her intention to resign effective upon the swearing in of her successor, Jerome Powell. Since Governor Powell’s confirmation hearing is set for November 28 of this year, it is possible for him to be confirmed and sworn in before the January 30–31, 2018, initial FOMC meeting, meaning that there could be only three sitting board members at that meeting. While most of the commentary between now and then will likely focus on Chair Yellen’s legacy, more relevant going forward are the implications of her leaving and the effects that efforts to fill the vacancies will have on policy during 2018.
The prospects are slim that any of the four vacancies can or will be filled in the very near future, perhaps not even as soon as mid-2018. First, there is the new requirement that was included in the reauthorization of the Terrorism Risk Insurance Act in 2014 requiring at least one board member to have supervisory or work experience in a community bank with assets of less than $10 billion. According to the WSJ, since the Trump administration has taken office, at least three potential candidates for this seat have actually turned down the position or withdrawn themselves from consideration because of financial divestiture or related requirements.1 This requirement is likely to take time to find an appropriate person; but once filled, that person, because of his or her background and work experience, is not likely to be major contributor to monetary policy and is more likely to focus instead on regulatory issues in cooperation with Vice Chairman Quarles.
As for the other vacancies, numerous names have been floated, but none have as yet been advanced. Who is chosen and what their backgrounds are will critically determine the path of policy. Once Chair Yellen is gone, there will be only one PhD economist, Lael Brainard, on the Board. We have written before that the dearth of economists on the board will put more emphasis on the board staffs’ recommendations, since the staff run the models for the Greenbook and prepare the policy options discussions in the Bluebook. The lack of a deep background in economics, econometrics, and the nuances of economic modeling will be a big disadvantage for the new Chair and non-economist appointees. In the case of the chair, the last three recent Fed chairs have all been economists.
Then there is the question of the politics of the upcoming appointments and the approval and vetting process that must take place before even a Senate confirmation vote can take place. Senate Democrats may not be able to block Fed nominees, but they can certainly delay consideration by employing a variety of tactics. There is always a possibility that Senate Democrats may choose the Fed appointments as the opportunity to retaliate against Republican strategies on both healthcare and tax reform.
So what happens to policy in the meanwhile? This is where the makeup of the FOMC and how the voting presidents position themselves will be important. There are five voting presidents. President Dudley, who is an economist but will also be leaving mid-year, is a permanent member. He has consistently voted with Chair Yellen and the majority, who have favored a gradual and patient approach to policy. He will be joined in 2018 by three other bank presidents who are also accomplished economists. They are President Bostic (FRB Atlanta), President Mester (FRB Cleveland), and President Williams (FRB San Francisco). The first vice president of the Federal Reserve Bank of Richmond will be the fourth member until a new president is selected.2 The Richmond Bank has had an economist as its president since 1972, so it is hard to see it breaking precedent at this time.
President Mester noted in a recent speech that she believes policy has achieved its employment objective but not fulfilled its inflation mandate. However, while she believes that it will take more time for inflation to reach the 2% target because of the lags in monetary policy, a continuation of the gradual increases in the policy rate seem appropriate at this time.3 In other words, she is comfortable with a path of gradual increases in the policy rate, consistent with the FOMC’s SEP rate projections.
John Williams has recently gone on record with the view that the economy is facing a “new normal” in which real interest rates are still quite accommodative, the equilibrium nominal short-term rate is about 2.5% (2 percentage points below the historic norm), unemployment is low, and real growth potential is about 1.5%, a consequence of low productivity growth and slow growth in the labor force. This view suggests a very cautious approach toward the management of interest rates and one that is heavily data-dependent.4
Finally, there is the newest FOMC member, President Bostic. His views echo much of what President Mester and President Williams have observed when it comes to the state of the economy and his dissection of the failure of the FOMC to achieve its inflation objective. He did observe that he doesn’t think policy has been too accommodative because, if it were, inflation pressures would be stronger than presently observed. However, he also indicated that, given the present state of the economy, he would not be uncomfortable with another rate hike in December, barring data suggesting otherwise.5
We glean from these remarks that the three incoming voting presidents on the Committee view policy as being on track and that all are comfortable with a gradual path for policy rate increases. At the same time, they all tend to see an equilibrium with lower inflation and lower economic growth in the near term. These are views consistent with those voiced and supported by incoming chairman Powell. Of course, there is considerable uncertainty concerning the likely path for inflation, and this was a major focus of Chair Yellen’s NABE speech this week. She expressed the view that inflation may be persistently low for some time and as a result policy may have to be more accommodative. Indeed, we have seen that uncertainty manifested in the continual write down of the FOMC’s expected terminal policy rate in its Summary of Economic Projections.
So at least for 2017, we should see – especially given the 3% real GDP growth in Q3 – a rate increase in December and a coalition of bank presidents and Chair Powell embarking on a cautious approach to policy in 2018, with two or possibly three more hikes, at the most, during the year.
2 President Rosengren is the alternate member for the Richmond Bank, and he too is an economist.
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