Fed Thoughts: Running Out The Clock

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Fed Thoughts Oct 2017

Vincent Reinhart

Vincent Reinhart - Chief Economist & Macro Strategist

The next chairman of the Federal Reserve (whomever that is) will have a lot on his plate, including bringing the policy rate toward a more normal level (whatever that is), continuing to shrink the Fed’s balance sheet for some time (whenever that ends), and adjusting the now shopworn communications policy (whatever way that may be). Yes, there are a lot of uncertainties, but the first sentence was written assuming that the one woman on the White House shortlist of five, Janet Yellen, will not get the nod. Never say never with the Trump Administration, but reappointing the incumbent would shred the President’s already tattered relationship with Senate Republicans. We claim no special insight into the workings of the process but would make three observations about the three frontrunners.

First, what people say in their current job does not necessarily predict their behavior in the next one. Jerome Powell is playing the cards he has been dealt—serving as a loyal Fed governor making sure the plumbing of money markets functions smoothly and defending in public the views of his chair on monetary policy. This makes him sound dovish but does not imply that he has abandoned his centrist Republican roots. According to Google Scholar, fully one-fifth of John Taylor’s academic citations owes to his 1993 paper describing his eponymous policy rule. Over the years, people have forgotten how modest was his claim at the time that "…it is important to preserve the concept of a policy rule even in an environment where it is practically impossible to follow mechanically the algebraic formulas economists write down to describe their preferred policy rules."1 He wrote down a rule, but he will not follow it mechanically. It is a good indication of the conventionality of the Fed shortlist that Kevin Warsh is viewed as the bomb-thrower in the group. Yes, he complained about the "guild" of economists running monetary policy. What economists hate to admit is that he has a point, in that much of the verbiage from the Fed represents economists talking to each other so as to make themselves feel better about their decisions. Lost in translation has been the responsibility to explain the purpose and conduct of monetary policy to the public, not just the cognoscenti.2 In the modern history of Fed appointments (starting the clock when the Employment Act of 1946 gave Washington officials the responsibility to foster full use of resources), both distinguished and undistinguished leaders have been drawn from outside academe.

1 Taylor, John B. "Discretion versus policy rules in practice." Carnegie-Rochester conference series on public policy. Vol. 39. North-Holland, 1993, p. 197.

2 The rising complexity and length of FOMC statements, documented here, is a good example of this failure to communicate.

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