Donald Trump's Fed Choice: Continuity or Disruption

By Greg Ip Features Dow Jones Newswires

In less than three weeks, President Donald Trump plans to announce who will run the Federal Reserve when Chairwoman Janet Yellen's term ends in February.

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He reportedly has six candidates, but the choice is really binary: Is he happy with how the Fed has run monetary policy? Or does he think it's broken and badly needs fixing? Of the six, two represent continuity, two promise disruption, and two are mysteries.

The continuity candidates

If Mr. Trump likes how the Fed has operated, he should simply nominate Ms. Yellen for a second term. Under her tenure, the U.S. has reached low unemployment with low (perhaps too low) inflation, the Fed's statutory goals, although growth has lagged behind previous expansions. Her qualifications aren't in dispute. She's a respected economist with a fully formed, coherent view of the economy and monetary policy. Markets understand her, and other Fed officials trust her. That's critical because the Fed operates by consensus, which puts a premium on the chairman's ability to persuade and compromise.

For Republicans, Ms. Yellen has two big drawbacks: She's a Democrat and a strong advocate of the postcrisis expansion in financial regulation. If Mr. Trump likes Ms. Yellen's monetary policy but wants it implemented by a Republican with a lighter regulatory touch, governor Jerome Powell fills the bill.

A lawyer by training, Mr. Powell served in President George H.W. Bush's Treasury Department, where he got crisis-management experience dealing with the collapse of Bank of New England and a bond bid-rigging scandal that nearly sank Salomon Brothers. He went on to work in investment banking and private equity. In 2012, President Barack Obama put him on the Fed, then chaired by Ben Bernanke.

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A non-economist as Fed chairman sounds as strange as a non-lawyer as Supreme Court justice. But some of the Fed's longest-serving and most influential leaders were bankers: Benjamin Strong (as head of the New York Fed) in the 1920s and William McChesney Martin in the 1950s and 1960s. Economic historians Christina Romer and David Romer have found that a chairman's success depends less on economic training than on economic beliefs.

Mr. Powell's economic beliefs and monetary-policy preferences are close to those of the chairmen under whom he has served, though he has worried more that the Fed's policies might fuel financial risk-taking. In 2013, he privately urged Mr. Bernanke to make clear that the Fed's bond-buying stimulus program -- known as quantitative easing, or QE -- would eventually end, according to Mr. Bernanke's memoir.

Their real difference is over regulation, where Mr. Powell has fretted that the postcrisis crackdown has gone too far, such as on proprietary trading, bankers' qualifications and loans to leveraged companies. This puts him on the same wavelength as the Trump administration, including Treasury Secretary Steven Mnuchin.

The disruptors

What if Mr. Trump doesn't like Ms. Yellen's monetary policy and wants to shake things up? Kevin Warsh, a scholar at the Hoover Institution, has positioned himself as the change agent. Like Mr. Powell, he has a law degree, worked on Wall Street, served a Republican president ( George W. Bush) and was a Fed governor under Mr. Bernanke. Unlike Mr. Powell, he is a vociferous critic of the Fed and what he calls the economics "guild" that populates central banking.

He has opposed QE. He has accused the Fed of trying to fine-tune the economy with each new bit of data, giving too much weight to theoretical economic models and too little to market signals, and of lacking an overall strategy.

Yet he has been vague about what this means and what strategy he would adopt instead.

Stanford University economist John Taylor is more explicit. A distinguished academic economist, he has since 2008 become a vocal critic of the Fed's unorthodox stimulus via QE and zero-interest rates, which he says have added to growth-stunting uncertainty. He would set rates according to a mathematical rule such as his widely-cited "Taylor rule."

The issue for both Mr. Warsh and Mr. Taylor is that they believe easy monetary policy is a cause rather than consequence of sluggish growth. Those beliefs, taken at face value, translate into higher interest rates. Unless they modify those views, they'll get pushback from current Fed officials who are mostly content with the current strategy and unsympathetic either to Mr. Warsh's critiques or Mr. Taylor's insistence on a rule.

The unknowns

Mr. Trump said in July his National Economic Council director Gary Cohn was then a candidate.

Mr. Cohn rose to No. 2 at Goldman Sachs Group Inc. and has been central in implementing Mr. Trump's efforts to roll back regulations and cut taxes. But he has left little evidence of how he thinks about monetary policy or the big macroeconomic issues in which the Fed chairman will be enmeshed.

John Allison, a former chief executive of bank BB&T Corp., has called for the abolition of the Fed and a return to the gold standard. Since neither is going to happen, his actual policy intentions are as much a mystery as Mr. Cohn's.

In deciding between unknowns, disruptors and continuity candidates, Mr. Trump has to select his priority: burnishing his self-styled image as a revolutionary, or leaving as is the one institution that can make or break the economy.

Write to Greg Ip at greg.ip@wsj.com

(END) Dow Jones Newswires

October 04, 2017 11:14 ET (15:14 GMT)