Thoughts About the Possible New Fed Chair
Rumors (or leaks) suggest that Jerome Powell and John Taylor are the leading candidates to replace Janet Yellen as Fed Chair, although Yellen was just interviewed a few days ago by the President. The consensus views Powell as most likely to continue Yellen’s somewhat dovish policies, while Taylor is widely considered to be hawkish and more likely to raise interest rates sharply. Both of these views may be incorrect.
Many of the people who favor current Fed Board member Jerome Powell to replace Yellen prefer him because they think he represents continuity and they also prefer that interest rates be kept as low as possible for as long as possible. In contrast, Taylor is thought to quite hawkish, because his “Taylor Rule” implies that interest rates need to be considerably higher with inflation close to the Fed’s target while unemployment is hovering at historic lows. These characterizations are simplistic and undercut a bit by the simple fact that Yellen favors a rate hike at the December FOMC meeting despite inflation remaining muted. Yellen could easily justify leaving rates unchanged if she were actually as dovish as she is perceived.
John Taylor does strongly favor having monetary policy follow a rule and it isn’t surprising he favors his own Taylor Rule. Even so, he has acknowledged publicly at the Boston Fed Conference, which I attended several days ago, that the Rule cannot be followed without consideration given to other factors. So, even Taylor would apply discretion to the output of the Rule. And if inflation were to moderate, contrary to the Fed’s expectations, he would probably be more inclined to normalize rates more slowly.
What’s driving Fed policy and how much is it really likely to change if Yellen is replaced? It is crystal clear that the Fed is responding to the ever growing scarcity of labor, as exemplified by the falling unemployment rate, in anticipation that labor costs and inflation will increase. No Fed Chair would tolerate a surge in inflation based on accelerating labor costs that we all can see unfolding before our eyes. Blame would be easy to place. Nonsensical claims notwithstanding, it is clear that labor is becoming scarce. The data also show that wage rates are accelerating. And it follows quite logically, even if the evidence is still sparse, that prices must eventually follow suit.
Yellen understands all of this and would not allow inflation to rise without a solid policy response, since a failure to act under prevailing circumstances would surely tarnish her legacy. Powell participates in all the internal policy discussions at the Fed, and while he’s not a trained economist, he certainly understands why his colleagues are voting as they have. As for Taylor, it is very likely that he would also support the Fed’s efforts to normalize interest rates before rising inflation becomes obvious. So the truth of the matter is that the Fed, with all its history and experience in trying to contain inflation at various times in the past, cannot ignore the existing conditions that set the stage for higher inflation without a careful response no matter who is running the show.
So we expect another rate increase at the December FOMC meeting, which also buys the Fed more time to observe how inflation and employment behave over the coming months. The Fed’s public projections suggest most officials expect three more rate hikes next year. If inflation picks up, as expected, those rate hikes are coming no matter who is running the show on Constitution Avenue.
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