Trump’s Fed Chair Problem (How Do We Awaken Dorothy From Her Monetary Oz?)

President Trump has a problem. And it is who to select as The Federal Reserve Chair by November 3rd. Of course, he can always keep mega-dove Janet Yellen. Or he choose someone new like National Economic Council Director Gary Cohn, Fed Board Governor Jerome Powell, former Fed Governor Kevin Warsh or Stanford University economist John Taylor.

I like the “Bay Area Brawl.” Berkeley’s Yellen versus Stanford’s Taylor. That is, if Taylor is actually going to follow his own Taylor Rule. And then it depends of who estimates the Taylor Rule.

For example, Glenn Rudebusch at the San Francisco Fed’s specification of the Taylor Rule says that the Fed Funds Target Rate should be 5.73% (compared to the actual rate of 1.25%).

Charles Evans of the Chicago Fed, on the other hand, has a Taylor Rule specification that indicates that the Fed Funds Target Rate should be 0.49%, BELOW the current target rate of 1.25%.

Yellen would be closer to dovish Evans while Taylor would be closer to Rubebusch.

But regardless of who Trump selects, it should be someone that actually follows a rule of some kind (whether Taylor’s rule or a complex rule) THAT IS PUBLICLY ACCESSIBLE.

In the following chart, I compare the baseline Taylor Rule (white line) with the actual Fed Funds Target Rate. Before January 2009, the actual Fed Funds Target Rate followed the baseline Taylor Rule (even though the actual target rate went from “too high” to “too low” during the 2000s. Then Chair Ben Bernanke looks like he was following a Taylor Rule UNTIL late 2008. Rather than allowing the Fed Funds Target Rate to go negaitve, he added the infamous quantitative easing (QE) in order to push down the 10 year Treasury yield. Thus, it was Bernanke that threw away the Taylor Rule (and Yellen after him). We are now in land of Monetary Oz (a dreamworld with Emerald Cities and flying monkeys), but no rule to speak of.

But what we do have in the US economy is asset bubbles.

Of course, slowly raising rates and unwinding the $4.4 trillion Fed Balance Sheet is likely the correct approach. There are no ruby slippers that the new Fed Chair can tap to return to monetary normality. But what prevents this same Monetary Oz fantasy from happening again?

Perhaps Trump should ask the candidates about what they would do as Fed Chair, while they are dancing.

Advertisements