Word is that President Donald Trump has settled on a shortlist of candidates to serve as the next chair of the Federal Reserve. How should the final choice be made? I recommend nominating a candidate who can lead the Fed through what are likely to be politically turbulent times.
We do not live under political normalcy, so traditional standards are not enough to guide this choice. In an age of consensus, it might be wise to nominate the candidate who knows the most about monetary policy, or who commands the most respect on Wall Street. Those remain significant factors, but the most important job of the next candidate is to prevent a polarization of opinion within the Fed itself.
Just look at American politics today. The Republican Party as we knew it seems to be collapsing, unable to pass significant legislation even though it controls the three major branches of government. We are seeing something close to a Republican civil war. The fissures in the Democratic Party are better concealed but no less serious. Different factions are still litigating Bernie versus Hillary, or vociferously debating identity politics. The parties are no longer coherent vehicles for social change.
This lack of political consensus is common to many Western countries; just look at the Brexit debates or the poor showing of the two mainstream parties in the German election, despite its economic boom.
The Fed has functioned as a technocracy for a long time, but might the future bring a Fed that is irrevocably split between competing factions? I don’t necessarily mean Republicans versus Democrats or even disagreements about monetary policy. Instead, the future could bring a Fed divided over how much it should assert its political independence, how much it should assume responsibility for possible asset bubbles, how it should respond to an international financial crisis, or how much it should align with an “America First” mindset. The Fed job is a lot more complicated and multifaceted than it used to be. It requires a more versatile candidate, who is willing to rely even further on Fed staff for support on the technical side.
The backdrop is this: Ben Bernanke’s Fed, with its bailouts during the financial crisis, ate up a lot of the Fed’s political capital, though arguably for the worthwhile cause of saving the financial system. As a result, the Fed no longer has its pre-crisis credibility. As long as the American economy is on the path of a slow and steady recovery, with relatively high asset prices, that’s bearable.
But the next time major economic volatility comes around, Fed decisions will be scrutinized and politicized like never before. This will happen in the mainstream media, on social media, and perhaps by our very own president in his tweets or offhand remarks. The key factor for any Fed leader will be the ability to maintain and project a coherent, unified voice at the Fed, so that the Fed remains an island of relative sanity in the polarized nation. This will be a problem of crisis management, but unlike Bernanke’s crisis management it will be fought first and foremost in the trenches of public opinion.
What does this mean for the short-listed candidates? Former Minneapolis Fed president Narayana Kocherlakota made a strong case in Bloomberg View for Janet Yellen, and I agree she has done a good job to date. I am less sure she will be able to lead and build consensus in 2019, when the appointed board members will all be Republicans and the bloom of the economic recovery may have worn off. She still deserves serious consideration, but I would judge her less on her monetary policy decisions and more on how she might manage relations with the board, president and public during a crisis. One of the major arguments in her favor is simply that Trump often appears to be tougher and more erratic with his own nominations than with holdovers from President Barack Obama’s era, and perhaps he would continue to regard her as one of the latter.
National Economic Council Director Gary Cohn was a former front-runner, and may still be in the running, but his recent public squabbles with Trump disqualify him by the above standards.
Candidates on the Republican side include former Fed board governor Kevin Warsh, current governor Jay Powell, Stanford University economist John Taylor and current Minneapolis Fed president Neel Kashkari, all with notable talents. I would prefer the one who, in the interviewing process, comes off as the most low-key, most able to build consensus, best with the news media, and perhaps has done the least to publicly lobby for the post.
Then compare that candidate’s leadership virtues to Yellen.
This time around, it’s all about the politics.