What is next for the Federal Reserve? It’s a question that has seized the economic world lately.
While the White House has remained relatively quiet so far about the world’s most important economic institution, President Donald Trump has the opportunity to appoint a new person to almost every top Federal Reserve System (Fed) position before his term is even halfway complete. Two spots on the Board of Governors have been unoccupied for nearly three years, a third will open in April when Governor Daniel Tarullo steps down and the terms of Chair Janet Yellen and Vice Chair Stanley Fischer will conclude in 2018. The White House will soon be able to partially remake the leadership of the country’s central bank.
However, the president’s own monetary policy views are about as indeterminate and transient as his standpoints on just about anything else. During his presidential campaign he declared himself at one point to be a “low interest-rate person.” At another time, he criticized the Fed’s adherence to low rates since the Great Recession for creating a “false economy.”
However, given his penchant for expressing the views of the last person he talked to, it’s worth examining the views of the radical monetary policy thinkers and Wall Street bankers in his inner circle.
Modern support for the gold standard exists only on the fringes of monetary policy thought and the U.S. has not promised to literally back up every dollar with a dollar’s worth of stored gold since the administration of Herbert Hoover.
However, the gold standard has support from several players with high levels of influence in the White House, including David Malpass, who is in the running for a top position at the Treasury Department. The president himself has echoed incoherent support for the gold standard. “Bringing back the gold standard would be very hard to do, but boy, would it be wonderful. We’d have a standard on which to base our money.”
Strictly tying the value of the dollar to such a limited commodity would restrict the Fed’s ability to respond to booms and busts. We’ve tried that approach before, and it didn’t work out so well. The U.S. abandoned the gold standard in the early 1930s when it was blamed for the government’s weak initial response to the Great Depression. Even though Trump operatives probably won’t be able to formally reinstate the gold standard without Congressional approval, a Fed influenced by gold standard supporters could weigh gold-driven philosophy more heavily in future monetary policy decision-making.
Currently, the Fed is tasked with buying and selling Treasury securities on the open market to fulfill the two branches of its “dual mandate,” which are maximum sustainable employment and low and stable inflation. But Mick Mulvaney, the director of the Office of Management and Budget, sponsored legislation while he was in Congress that would have instructed the Fed to focus only on controlling inflation and to pay no attention to the strength of the jobs market. That could have serious consequences. Suppose we were ever to return to the economic conditions of the 1970s with high inflation and a weak jobs market, known as stagflation. Mulvaney’s approach would compel the Fed to run a tight monetary policy and to pay no attention to the weak jobs market. Mulvaney and others who favor his approach have to face the fact that monetary policy has worked pretty well under the current approach. The U.S. economy has seen better outcomes than many European economies, whose central banks often prioritize inflation and have seen double-digit unemployment. Mulvaney has a powerful ally in Vice President Mike Pence, who also sponsored legislation to end the dual mandate, and their influence could ensure that their peers receive a full hearing. Repealing the dual mandate would require an unlikely act of Congress, but Trump’s appointments could give rise to a more inflation-phobic Fed in the next few years.
It is possible that the Fed may adopt a rules-based approach to monetary policy. Instead of the Fed setting its benchmark federal funds rate based on the judgment of its policymaking arm, the Federal Open Market Committee, it would do so according to some version of the Taylor Rule, which prescribes a target federal funds rate based on deviations from target inflation and output. If the Taylor Rule was instated now, it would call for the Fed to set a federal funds rate much higher than its current level, which would instantly raise all interest rates and aggravate financial markets.
Furthermore, courageous deviations from the Taylor Rule’s prescriptions on the part of then-Chair Ben Bernanke were instrumental in lifting the economy from the depths of the Great Recession. Rules-based monetary policy verges on oversimplification and its foolish consistency and lack of consideration for the complications of the broader macroeconomic environment could lead to misguided policymaking. John Taylor himself, the architect of the Taylor Rule, is rumored to be a top candidate for Yellen’s replacement, so a more rules-based approach is not out of the question.
At the end of the day, the Fed was designed to be insulated from the full force of the populist streak that currently drives American politics in order to protect its mandate from political opportunism. While Trump’s appointments may try their hardest to set the goals of the Fed on a different course, we can have faith that the Fed will continue to pursue its mandate with nothing but coldly apolitical expertise.