As of yesterday, five Fed contestants have moved from the swimsuits and evening gowns into the monetary and regulatory policy talent contest. Although President Trump’s beauty pageants typically included a panel of high-glitz arbiters, this time it’s just him making the decision. More fun for him, of course, but one has to wonder what happens to a central bank when the battle to chair what is supposed to be a collegial, expert, and independent agency takes on all the attributes of a Las Vegas event, smoke and mirrors included.
To be fair, the spectacle attending this Fed assumption isn’t all due to President Trump’s penchant for showmanship, uncertainty, and control. I can think of no time in which global prosperity hung so precariously on each action of the U.S. central bank. Will it tighten too fast and trigger an emerging-market debacle? Will QE’s unwind proceed without market chaos? Will a quarter of a point in December throw global equity markets into a swoon, perched as high as they are on unprecedented P/Es that are themselves artifacts of Fed policy? What of the bond market always poised for a bursting bubble? Will the Fed come to recognize its role as arbiter of economic equality and thus help to stabilize American politics? When a central bank’s decisions reach so deeply into every corner of the global financial system and national social welfare, no wonder the question of who makes these calls has taken on a talismanic aura.
Is this good for the Fed? Of course not. Any entity this powerful may come to feel omnipotent and infallible. Indeed, any entity this powerful had better be omnipotent and infallible – even a small boo-boo could have fatal consequences given the narrow margins of error governing each Fed policy call.
Perhaps understandably, the Fed has fallen prey to the insularity that often comes with feelings of omnipotence and infallibility – why be among the few global central banks refusing to revise the post-crisis rulebook as worrisome signs emerge of unintended consequences? We did it and therefore it’s right until we decide it isn’t appears to be current policy. Could QE be backfiring? Chair Yellen charmingly admitted in September that she really doesn’t know if the Fed’s $4.5 trillion book has made much of a difference. Still, the Fed is moving with unbelievable caution to dismantle it despite growing consensus about QE’s adverse distributional impact. Maybe QE hasn’t worked, but the Fed seems to think we still have to have it because they once wanted it and haven’t figured out with what to replace it. What would make inflation move to target? Is the target even right? What neutral rate works on a going-forward basis given post-crisis market reconfigurations, including the sharp shift to shadow financial institutions and the resulting disintermediation which the Fed has only begun to discuss behind its tightly-closed doors? The Fed will readily admit that big-bank rules are redefining financial markets in risky ways. Change? Not yet.
As I said last month, Fed staff are an impressive lot with unmatched expertise. But they live in what has become the central bank equivalent of the Vatican. Insulated from the secular rabble, decisions are based on canonical models, formulas, and high-minded objectives increasingly removed from financial-market and political realities. Lots of great staff work is evaluating the unintended consequences of all of these scriptural assumptions, but the monetary and regulatory liturgy remains stubbornly immutable as it awaits a new Pope who staff hope will already be a fervent convert to its way of thinking
Given this President’s predilections, the next head of the Fed will be announced with reality-show drama surpassing the thrill once evoked by the first puffs of white smoke. It will take tremendous skill for the next Fed chair to change the Fed, bring it back to the far more limited role it should have in a market economy, and recraft regulations to enhance not only financial stability, but also growth and inclusion. I’ll say a prayer.