Will Yellen Be Replaced as Chair of Federal Reserve?

Will Yellen Be Replaced as Chair of Federal Reserve?

This article originally appeared on Economics Wire.

Janet Yellen became the first woman to Chair the Federal Reserve, the United States’ central bank when she was sworn in after Ben Bernanke’s retirement in 2014. Her four-year term will be expiring early next year, at which point President Trump can either re-nominate her for another four-year term or select another candidate to nominate.

Yellen’s accession to head the Federal Reserve has followed remarkable stability in that position. After Paul Volker became Fed Chairman in 1979 and successfully tamed inflation through monetary policy, American politicians in the main have respected the independence of the institution and the benefits of doing so. Each Fed Chair since Volker has been able to select their own timeframe for leaving and often play an important role in recommending their successor. After Volker’s eight years on the job, Alan Greenspan lasted nineteen years and Ben Bernanke another eight. That era may be passing.

According to The Wall Street Journal, Trump met with Yellen shortly after his inauguration and informed her that he thought she was a “low-interest rate person like myself.” It would be hard for any observer to not conclude that Trump prefers a continuation in the accommodative policies the Fed has maintained since 2008. During the Presidential campaign, the future President stated that he would not nominate Yellen for another term solely because she is a Democrat.

If Trump wants interest rates to stay extremely low, then he cannot be too pleased with the Fed’s recent decisions headed by Yellen. Yesterday it was announced that the Fed Funds rate would increase by another 25 bps, to put it in a range of 1.00% – 1.25%. After interest rates were lowered to between 0% and 0.25% in 2011, they were kept at that low level for four and a half year. Three further interest rate increases have happened since then, all since Trump was elected.

The extremely accommodative position the Federal Reserve took during and after the financial crisis worried some economists that it would lead to higher inflation. To date, that has not yet occurred, as deleveraging, labor slack, and a strong dollar has kept it in check. That does not mean that without further tightening the risk of higher inflation would be nil.

By almost any measure, monetary policy is still quite accommodative. The Taylor Rule is the most common yardstick for what the Federal Funds rate would be set at using a rules-based approach. It takes into account how much inflation and GDP have deviated from their targets, and thus how the Federal Reserve should set policy to comply with its dual mandate of low inflation and full employment.

The actual Fed Funds rate and the one predicted by the Taylor Rule.

Since 2003, the Federal Reserve has more or less consistently set interest rate policy more aggressively than the Taylor Rule would imply is appropriate. With yesterday’s increase, the Federal Funds target rate is now between 1.00% and 1.25%, with a current effective rate of 1.16%. But, the Taylor Rule suggests that it should be more like 3.5%. That may sound draconian, but the slack in the labor market appears to have been absorbed with the unemployment rate at multi-year lows and while inflation is hovering at the targeted 2%, it has been rising from lower levels.

No one can predict what President Trump will do. Goldman Sachs alum Gary Cohn is leading the search and some have suggested that he could end up filling the job himself. While selecting someone else to be the next Fed Chairman is within the purview of the President and would not necessarily be worrisome, it must be done for the right reasons. We have seen what happens when monetary policy is set by politicians and it is not a movie the United States would want to watch again.

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