Crazy Days At The Fed
It’s been a wild few days for the Federal Reserve. First there was the disappointing August employment report that put its entire rate hike strategy in doubt. Then, on Tuesday, Federal Reserve Governor Lael Brainard attacked the entire premise behind the Fed’s current rate increase projections. Yesterday, Vice Chairman Stanley Fischer resigned effective in mid-October, citing the ever popular “personal reasons”. And Trump ended the day by announcing that Gary Cohn would not be considered to replace Janet Yellen as Fed Chair.
Brainard’s broadside was intended to sway her fellow Board Members, as most Governor’s comments are. Her argument is that the Fed has consistently overstated future inflation for the last five years despite robust growth. She posits that what she calls “trend inflation”, the underlying natural rate of inflation, is much lower in the post-financial crisis world than what we have traditionally been used to. She says, “a variety of measures suggest underlying trend inflation may currently be lower than it was before the crisis, contributing to the ongoing shortfall of inflation from our objective.”
That, of course, would explain why inflation has continually run below the 2% target and implies that the Fed’s models are continually overstating future inflation. That, in turn, implies that the necessity of rate hikes in order to nip the expected surge in inflation as we reach full employment is also misguided. In fact, Brainard suggests that the only way to bring inflation up to the 2% target is to specifically state that the Fed should allow inflation to overshoot the 2% target. Says Brainard, “To the extent that the neutral rate remains low relative to its historical value, there is a high premium on guiding inflation back up to target so as to retain space to buffer adverse shocks with conventional policy. In this regard, I believe it is important to be clear that we would be comfortable with inflation moving modestly above our target for a time.”
Fischer’s resignation was only surprising in that he only had about eight months left in his term. Fischer was an experienced central banker, having led the Bank of Israel from 2005 to 2013 before being appointed to the Fed by Obama. With his departure and the expiration of Yellen’s term next February, there will be great uncertainty for monetary policy in the next few months. That uncertainty is exacerbated by the disputes within the Fed exemplified by Brainard’s comments. In addition, there are now a ridiculous four openings on the Fed Board and the regional presidents actually now have more votes on the FOMC than the Board does. This is just another reflection of the failure of the Republican party and now Trump to fulfill the basics of governance.
Finally, the Wall Street journal is reporting that Gary Cohn’s comments criticizing Trump for his response to the racist, white nationalist rally in Charlottesville had essentially ended Cohn’s hopes for being appointed Fed Chair when Yellen’s term expired. Cohn had reportedly been hanging on in the Trump administration specifically to get this job. According to one White House insider, however, Trump’s fury at Cohn over his Charlottesville comments means that Cohn is “more likely to get electric chair than Fed Chair”. Ouch!
On the other hand, Trump will eventually need to fill those Board vacancies and figure out what to do about a chairman. If the past is any guide, he will end up picking the worst possible candidates. At this point, vacancies may be better than what we get. In any case, as I noted above, the trend lines for job and wage growth are declining even as the Fed is focused on rate hikes and unwinding its balance sheet. That alone would create uncertainly about monetary policy going forward but that uncertainly is now compounded by the leadership void at the central bank.
