ECON430-Topic #4: Rethinking the Role of Central Bankers

There has been some speculation in the weeks since Donald Trump was elected president that the Fed would be in for some drastic changes in the coming years. While Janet Yellen has indicated that she is not prematurely stepping down from her role as Chair of the FOMC in January 2018, it seems unlikely that she will be reappointed following the end of this four-year term. She could even buck tradition and opt to stay on as a governor and serve out her 14-year appointment. On the heels of the Dodd-Frank Act changes being implemented, and with a GOP-led House and Senate there is likely to be a much more hawkish future Fed Chair and far fewer regulations on banks and banking. There may also be several changes to the Fed mandate in coming years, either requiring a GAO audit of policies, requiring rule-based policy, ending their emergency lending powers, or changing the makeup of the FOMC to hand some power from governors to presidents. It is even possible that the next Fed Chair would be someone not so interested in keeping the Fed around at all.

It appears the Trump administration will be nominating Steve Mnuchin as Treasury Secretary. However, the Trump administration has entertained the idea of selecting John Allison as Treasury Secretary, a former bank CEO who favors eliminating the Federal Reserve and returning to the gold standard. Of the other leading potential picks for the job, Jeb Hensarling–current chair of the House Financial Services Committee–has also been highly critical of the Fed. Hensarling’s criticism is more in line with those who want more transparency and accountability from the Fed. These possible picks for Treasury are distinctly at odds with those views from Janet Yellen, who notes that expansive spending programs while at full employment would likely result in inflation. Furthermore, those who are considered for Treasury Secretary are often later considered for Chairman of the FOMC.

Note, that the Fed–along with the FDIC–is in charge of regulating much of the banking system. Perhaps there are too many regulations on things such as capital and reserves leading to slower growth, or perhaps there is too little being done to prevent the next bubble.

Questions you might consider:

  • How would you expect markets to react to any of the prospective policy, rule, or regulatory changes. You might also consider the economic changes due to these potential Treasury/Fed selections.
  • Has anyone else discussed what might happen if the new administration’s economic policies are put into place while the economy is operating at its current level? What changes do you expect the Fed to put into place if there are significant increases to government spending or more tax cuts? How would the Fed go about doing this?
  • How would you expect structural changes to the Federal Reserve to impact functioning of the financial markets and banking systems? If the FOMC shifted to having more power in the hands of presidents, instead of governors, what changes would you expect to occur?

13 thoughts on “ECON430-Topic #4: Rethinking the Role of Central Bankers”

  1. Since Trump’s election victory financial markets have responded positively to indications that there could be financial sector deregulation and a fiscal policy stimulus. In particular, bank stocks have gained approximately 18% during the month of November, according to the first CNBC article, which suggests that markets approve of Trump’s deregulation promises such as the repeal of Dodd-Frank. Consequently, markets are betting on Trump’s expansionary fiscal policy agenda which has subsequently fueled gains on infrastructure and construction stocks as well as related commodities according to the article by MarketWatch. Similarly, Trump’s nomination of Steven Mnuchin for Treasury Secretary has the potential to send markets even higher. As the second CNBC article points out, the nomination of Mnuchin in light of his background as a financier with deep ties to Wall Street underscores the incoming Trump administration’s commitment to financial deregulation and support for business.

    However, on the other hand, proposed reforms for the Federal Reserve would be expected to send markets downward. In particular, as the Brookings article notes, constraints on the lender of last resort function of the Fed would be a significant disruption to the traditional role of the institution and could call into question the Fed’s ability to intervene in the financial sector in the event of another crisis. Consequently, changes to make the Fed’s monetary policy subject to audits by the Government Accountability Office would, as the Brookings article also notes, add increased complexity and uncertainty to FOMC decisions. Furthermore, it could subject monetary policy to explicitly political influence. Its likely that investors would perceive these increased risks and greater uncertainty and would shift their portfolio holdings accordingly which could precipitate a sell-off in financial markets.

    (1). http://www.cnbc.com/2016/11/30/bank-stocks-rise-nearly-19-percent-on-pace-for-their-best-month-in-history.html
    (2). http://www.cnbc.com/2016/11/29/donald-trump-is-reportedly-expected-to-pick-steven-mnuchin-as-treasury-secretary.html
    (3). http://www.marketwatch.com/story/trump-has-unleashed-the-stock-markets-animal-spirits-2016-11-30
    (4). https://www.brookings.edu/testimonies/examining-federal-reserve-reform-proposals/

  2. President-elect Donald Trump has proposed an array of regulatory, fiscal, and political reforms that would have significant structural impacts on the US macroeconomy. Of particular concern is his proposal to amend the tax code. While there are certainly benefits at the individual and business level, most superficial analyses of Trump’s plan often overlook the implications that such demand-inducing policy will have on the Federal Reserve’s ability to manage output and inflation. It could be argued that these deep income tax cuts (35% to 15% for corporate tax, 39.6% to 25% for top individual bracket), simplification of tax code (7 brackets to 4), and elimination of NIIT (the ACA-imposed net investment income tax of 3.8%) would have had significant stimulative effects on the economy. But considering that the US may very well be at full employment at present (assuming such a level of employment exists or is relevant), Trump’s proposed expansionary fiscal measures may have sizeable effects on the rate of inflation which the Fed may lack the ability to control considering current historically low interest rates. This is not to mention the effect that such deep cuts in government revenues may have on deficits and the national debt (estimated $9.5 trillion increase over a decade). No matter what one’s stance on these Trump’s proposed tax code reform, it is necessary to consider the externalities of lower taxes, increased aggregate demand, and thus inflation on monetary policy in this unprecedented time of near-zero rates and balance sheet expansion.

    http://www.npr.org/sections/thetwo-way/2016/11/17/502480053/federal-reserve-chair-throws-cold-water-on-trump-economic-plan
    http://taxfoundation.org/article/details-and-analysis-donald-trump-s-tax-plan
    https://www.ft.com/content/73262cb8-a72e-11e6-8898-79a99e2a4de6

  3. When a past chairman of the Federal Reserve assimilates the official communications from the Federal Open Market Committee (FOMC) to a document that seems to have been prepared by a large committee, it cannot be a good sign. To make matters worse, Bernanke believes that in order to better understand the Fed’s intentions one should, “try to infer the FOMC’s policy inclinations from the views expressed by individual FOMC participants in various forums.” If the economy and the people in charge of it are having a tough time discerning the direction the FOMC want’s to steer the economy, something needs to be done. The prospective policy change for the Fed having to be completely transparent about monetary policy would be beneficial to markets. The concrete reasoning behind the instruments the Fed imposed on the economy would seemingly enable private market participants to obtain a better grasp on the market and the Fed’s intentions, resulting in a positive reaction from the economy.

    The new President of the United States will have the opportunity to replace a majority of the Fed’s board members along with a Treasury Secretary. Out of those in the running, all three seem to share a similar desire for deregulation of the financial sector. Deregulation could initially have a positive effect on the economy, but should be done with memories of what caused the Great Recession in mind. Due to the way each of the three potential Treasury Secretaries feel about the Fed, the US should expect deregulation in the financial industry and more clarity from the Fed in the near future. Both of which should, when coupled with Trump’s desire for tax cuts an increased military spending, produce positive reactions in the economy.

    https://www.brookings.edu/blog/ben-bernanke/2016/08/08/the-feds-shifting-perspective-on-the-economy-and-its-implications-for-monetary-policy/

    https://www.brookings.edu/testimonies/examining-federal-reserve-reform-proposals/

    http://www.nytimes.com/2016/11/13/business/economy/trump-the-fed-yellen-gets-ready-for-reckoning.html?_r=0

  4. If the Fed would switch to a ruled based monetary authority, then markets could react accordingly in a multitude of way. The outcomes of the market would most likely depend on the openness of the Fed. If for example the Fed decided to switch to a monetary rule and broadcasted the rule they were using to the public, then it could be expected markets would react positively. This would be due to the fact that markets would now be able to fully expect how the Fed will respond when raising and lowering interest rates. If they know how the Fed will respond, they can better use foresight to adjust to the fluctuations in the market, now that they have better information. If the Fed switches to a rule, but does not broadcast the type of rule they will use, then markets will likely respond negatively. Markets could become chaotic because there understanding of Fed policy would become further muddled. While they may know that a rule is in place, if the rule is not transparent then there understanding of how the rule will act and what information is used to formulate this rule would be unknown. This should cause markets to spiral downward because at that point monetary policy would be anyone’s guess in the short term and it could be very difficult even in the long term to decipher Fed policy. While a rule seems to operate under a transparent regime, it can be seen how rules may not be as visible and clear to markets as it may seem. If a rule is put into place and it is not transparent then it can be expected, at least in the short term that anything could happen.

    Sources Used

    https://research.stlouisfed.org/publications/review/99/03/9903wp.pdf

    https://www.brookings.edu/testimonies/examining-federal-reserve-reform-proposals/

  5. Trump’s presidency is just at a starting point, and it is way too early to accurately predict what the future economy will under Trump, all the market can do is speculate according on his actions. Soon after winning the election the market reacted fast, in the past few weeks the Dow Jones Industrial Average has been closing at all times high (closing at 18,259 before the elections and closing at 19,216 as of December 5th) as there is positive speculation that a single-party controlled government will move the market forward. To add to the positive market speculations Trump is to pick Steven Mouchin as the Treasury Secretary, Mouchin was the chairman at Dune Capital Management and then served as the financial chairman for Trump’s presidential campaign, this bring in even more confidence to investors as Mouchin plans on lowering business taxes in accordance with Trump’s plan of cutting them from the current 30% to 15%, lower business taxes will hopefully lead to more corporations doing business inside the U.S which increases the investment.

    The financial reform acts mentioned by Donald Kohn are to be watched for a positive economic future. According to Kohn the GAO audits will bring unwanted political pressure on Fed decisions while the new regulations on reporting, collateral requirements and approval from the Dodd-Frank act will limit the effectiveness the Fed has on maintaining confidence and liquidity in the market. Investors can look happy as Trump has talked down the Dodd-Frank act and plans to repeal it.

    But the positive speculation might take a turn for the worst, as for interest rates the story is different. It is usual for politicians to prefer low-interest rates even at the expense of future inflation, Trump himself as a borrower prefers low rates but for Trump’s plan of fiscal policy stimulus will be reached better with higher interest rates rather than low ones. The danger of high interest rates could hurt the confidence of the market.

    http://www.nytimes.com/2016/11/13/business/economy/trump-the-fed-yellen-gets-ready-for-reckoning.html
    https://www.brookings.edu/testimonies/examining-federal-reserve-reform-proposals/
    http://www.cnbc.com/2016/11/29/donald-trump-is-reportedly-expected-to-pick-steven-mnuchin-as-treasury-secretary.html
    http://money.cnn.com/data/markets/dow/

  6. If Janet Yellen decides to serve the remainder of her term as Chair of the FOMC until 2018, it’s not a matter of if President-elect Donald Trump will clash with the Fed but when. With Trump’s looming expansionary fiscal policy, Fed officials are fearful of having to accelerate raising interest rates to accommodate for the rise in inflation. If this monetary policy is interpreted as an attempt by the Fed to undermine the incoming administration’s fiscal policy, it may accelerate implementing legislature to restrict the Fed’s powers.
    Trump and members of his political team were critical of Yellen for supposedly using policy in favor of Democrats. Republicans, who now control Congress, are also expected to make a push for the use of a benchmark rule such as the Taylor Rule that sets interest rates at a systematic rate. This would eliminate the Fed’s ability to use discretionary quantitative easing outside of rare circumstances. Current New York Fed President William Dudley argues that resorting to automatic monetary policy would make the Fed susceptible to short-term political pressure. Dudley also argues that had the Fed resulted to the Taylor Rule in 2008, it would have been a disaster for the economy. So although Trump is claiming to promote a central bank separate from political influence, he and the Republicans may actually be doing the opposite and setting themselves up for failure.

    http://www.reuters.com/article/us-usa-trump-fed-analysis-idUSKBN13Q5H6
    http://www.businessinsider.com/trump-and-the-fed-may-clash-2016-12
    http://www.reuters.com/article/usa-fed-dudley-washington-idUSL1N1E00U6?feedType=RSS&feedName=bondsNews

  7. It should be worrisome to Americans that Donald Trump has taken the reins of the largest economy in the world, given his blatantly poor misunderstanding of economic fundamentals. This has been shown in the debates, where Trump simultaneously claimed that the Fed is creating a “nasty bubble” by keeping rates low but also claimed that the economy would tank if the Fed raised rates only moments later.(1) He has also claimed that raising rates “would be a disaster” 4 months before that debate.(2) Trump appears to be more bark than bite following the election as he has already reneged on repealing Obamacare (3), prosecuting Hillary Clinton (4), and building “the wall.” (5) So who is really to say what actions he will undertake in regards to the Fed. The market is pricing in a few predictions, the primary one being the repatriation of international profits into the US which would stoke inflation and make the case for a rate hike much more compelling. The market is pricing in a 94% chance of a 25 bps increase in December based on futures as the Fed will have to turn hawkish to combat expected inflation. (6) Decreased banking regulation would be a 180 from the system we have grown to know in the last 8 years during our long recovery, but many are in support of decreased regulation such as repealing Dodd Frank. President-Elect “The Don” will likely find it harder to achieve his campaign promises than many of his constituents believed (7), so it is difficult for market participants to bet heavily on what the future will hold. For most of us, we will be forced to sit back and watch the show.

    1 – http://www.wsj.com/articles/donald-trump-attacks-federal-reserve-yellen-during-debate-1474946709
    2 – http://blogs.wsj.com/economics/2016/09/12/donald-trumps-shifting-words-on-interest-rates-and-janet-yellen/
    3 – http://www.investors.com/politics/editorials/did-trump-just-renege-on-his-pledge-to-repeal-obamacare/
    4 – http://www.politico.com/story/2016/11/trump-clinton-investigation-kellyanne-conway-231735
    5 – http://www.alternet.org/election-2016/here-are-4-policies-trump-already-back-pedaling
    6 – Bloomberg Terminal – Function “WIRP”
    7 – http://www.cnbc.com/2016/11/21/repeal-dodd-frank-it-wont-be-easy-for-donald-trump-to-end-the-rule.html

  8. Throughout his campaign, Mr. Trump has been very critical of Janet Yellen and the Federal Reserve. He believes that the U.S economy has relied too heavily on monetary policy and the manipulation of interest rates to generate growth, stating that the Fed was supporting a “very false economy by driving asset prices to unsustainable heights” (Appelbaum, 2016) and is encouraging excessive speculation as a result. He instead advocates for a “focus on growth-oriented structural reforms, tax reforms, trade reforms, regulatory policy, and energy policy (Appelbaum, 2016). With the board having two vacant seats and Yellen’s term ending in 2018, the president-elect can fill a majority of the Fed’s seven-member board with his own nominees over the next 18 months and could lead to significant structural changes to the Fed as philosophies on how to enact monetary policy changes within the board. However, instead of relying on the Fed and monetary policy, Trump has opted to use a number of fiscal policies and reforms as a primary tool in hopes of stimulating the economy.

    During his campaign, Trump “pledged to cut the U.S corporate tax rate from more than 30% to 15%” in an attempt to encourage firms to keep their tax address in the United States (Pramuk, 2016). Furthermore, the president-elect has vowed to implement large tax cuts on the wealthy and middle class to stimulate more spending. The new administration believes that the loss of government revenue due to a tax cut on firms will be offset by the increase in personal income taxes collected due to the higher number of people that will have jobs, despite lower rates. Furthermore, the selection of Steven Mnuchin as Trump’s Treasury secretary (owner of his own investment firm and a Wall Street investor) could lead to changes in regulation for the financial sector. As he said in an interview with CNBC, Mnuchin acknowledged that some changes will be made to the Dodd-Frank policy that was implemented to serve as regulatory reform on the banking system, including changes or even the removal of the Volcker Rule that prohibits banks from making short-term proprietary trading. He claims that the rule is “too complicated and people don’t know how to interpret it” (Sorkin, 2016). Therefore, we can expect looser regulations on how much and to who banks can lend in an attempt to promote more lending to small and medium size firms to stimulate spending and create more jobs. The new administration has to careful when implementing expansionary fiscal policies and allowing banks to loan more freely in the market or else they will be faced with high and undesired levels of inflation.

    Works Cited:
    http://www.nytimes.com/2016/11/30/business/steven-mnuchin-expected-treasury-pick-is-an-outsider-to-public-policy.html
    http://www.cnbc.com/2016/11/29/donald-trump-is-reportedly-expected-to-pick-steven-mnuchin-as-treasury-secretary.html
    http://www.nytimes.com/2016/11/13/business/economy/trump-the-fed-yellen-gets-ready-for-reckoning.html?_r=0

  9. Trump has stated he has plans to make big changes to the economy, especially in the Fed. It is known he would like a weaker Fed and a shift of its some power to the president. Trump has stated he wants to apply a fiscal stimulus sending the economy into expansion (1). If this were to occur, markets would expect to increase. Also, Trump has criticized the Dodd Frank act, for cutting lending and curbing the economy (2). If he were to remove this act, markets again are expected to rise, as it would be easier for banks to make loans. A different possible expectation if the Dodd Frank act is removed would be that another bubble would expect to form and eventually leading to another recession. If this is what expectations formed, markets would drop, brought about from an increase in uncertainty. Trump has also met with John Allison about appointing him to become his Treasury Secretary. Allison has stated in the past that he believes the economy should return to the gold standard (3). Being that Allison is a fan of more confidence in the currency, markets would expect to increase as there is less uncertainty about the future value of the dollar, causing investors to possibly seek out more loans. Overall there is a lot of uncertainty surrounding Trump’s economic plan and only time will tell what changes Trump will bring to the economy.

    Sources:
    (1) https://assets.donaldjtrump.com/_landings/contract/O-TRU-102316-Contractv02.pdf
    (2) http://www.npr.org/sections/thetwo-way/2016/11/17/502480053/federal-reserve-chair-throws-cold-water-on-trump-economic-plan
    (3) http://www.businessinsider.com/trump-meeting-john-allison-bank-ceo-abolish-the-fed-gold-standard-2016-11

  10. Mr. Trump has pledge $1 trillion for infrastructure spending program to boost the economy. However, Federal Reserve Board Chair Janet Yellen emphasized that the economy is currently operating “relatively” close to full employment, implying that while a big boost with fiscal stimulus was needed after the devastating financial crisis that took place in 2008 due to high rates of unemployment, this is not the case now.
    Investors have predicted that the expansive fiscal policy proposed by Mr. Trump would lead not only to stronger economic growth and higher rates of inflation, but also to a faster pace of interest -rate increases by the Federal Reserves, which totally contradicts what has been happening since the financial crisis: soft growth, low inflation, and slow peace of tightening interest rate policy.
    In addition, it has also been argued that if the economy start growing quickly as a result of economic policies enacted by president-elected Donald Trump, the Fed will likely raise rates.
    However, President of the Federal Reserve of Dallas Robert Kaplan implied that he would not offer hypothetical prediction about what might happen after President-elected Donald trump takes office in January because it is to soon to predict what decisions the Fed will adopt based on Mr. Trump’s economic policies because Fed’s reaction will be based on the combination of policies adopted.
    Despite expectations about positive economic growth after elections, market is pricing a 94% chance that the Fed will raise interest rate at its December meeting.

    http://www.wsj.com/articles/u-s-government-bonds-still-pulling-back-1481038891
    http://www.wsj.com/articles/feds-kaplan-says-too-soon-to-say-how-trump-will-affect-rate-outlook-1480618233
    http://www.nytimes.com/2016/11/13/business/economy/trump-the-fed-yellen-gets-ready-for-reckoning.html
    http://www.wsj.com/articles/dollar-rises-to-highest-level-since-2003-on-strong-data-1479913930

  11. One policy put forth by President-elect Trump that, for reasons beyond me, no one has conducted serious analysis on is the plan to erect a wall between United States and Mexico. According to our soon-to-be fearless leader, “Building a wall is easy, and it can be done inexpensively.” I am sure Trump has built several walls during his lengthy and questionably successful real estate career, but our President-elect may be neglecting to consider some of the economic ramifications of constructing something so grand. One vulnerable industry that should be of special interest is agriculture. Roughly 1.4 million undocumented immigrants work on U.S. farms each year, or about 60% of the agricultural labor force. Without this key source of labor, harvested crop shortages and increased food prices can be expected. A study conducted by the American Farm Bureau Federation last year found that boosting deportations and tightening border security would cause food prices in grocery stores to climb 6% and cut average net farm income by as much as 30%. While no specific level of immigration constriction is specified in the description of the study, my guess is Trump is on the extreme end on the spectrum. One may be enticed to think that as immigrants exit the U.S. agricultural industry, this will leave available jobs for U.S. citizens, but this may not be the case. In California, where farm work is in highest demand, the average field laborer makes $12.35 an hour. Compare this to construction, often viewed as a step up from farming, where workers made an average of $20.24 an hour. This creates a scenario, which has already been viewed by U.S. farmer owners, where farm hands are all too eager to leave farms short labor in their search for better pay. It is unclear as to whether the wall will actually be built, but I struggle to see how it will make America great again.

    http://www.politico.com/story/2015/09/donald-trump-2016-farmers-fear-argriculture-213201

    https://www.washingtonpost.com/politics/trump-on-the-us-mexico-border-building-a-wall-is-easy/2015/07/16/9a619668-2b0c-11e5-bd33-395c05608059_story.html?utm_term=.2aadf727d372

    http://www.bloomberg.com/politics/articles/2016-06-06/crops-rot-while-trump-led-immigration-backlash-idles-farm-lobby

  12. As others have suggested, due to the President-elect’s penchant for untruths during his campaign it is difficult to predict exactly what will happen to the Fed under the Trump presidency. However, given his consistent attacks on the Fed and Janet Yellen it seems likely that Trump will enact significant change to the Federal Reserve. Almost certainly, this will result in a Federal Reserve Board which is more conservative and more relaxed banking regulations. Hopefully, this will stimulate growth without allowing for large increases in inflation or another bubble like the Great Recession to occur. It is less likely, but still possible that the Trump administration would work to severely limit the power of the Fed. While this may seem absurd to most economists, the combination of a “post-truth” climate (1) and decreasing trust in institutions (2) might allow for such a thing to occur. On the other hand, there is hope that Trump will come to see the benefits of the Federal Reserve system and weaken his intentions to reform the Fed, as was the case with Reagan and Volcker’s Federal Reserve (3).

    1. http://www.economist.com/news/briefing/21706498-dishonesty-politics-nothing-new-manner-which-some-politicians-now-lie-and
    2. http://www.gallup.com/poll/1597/confidence-institutions.aspx
    3. http://www.nytimes.com/2016/11/13/business/economy/trump-the-fed-yellen-gets-ready-for-reckoning.html

  13. Many questions arose the day after election day as many analysts react to the election of Donald Trump as our next president. Discussions about Trump’s possible appointees and comments in the past may do to the Federal Reserve structurally, these alone have raised questions about the possible change in the Fed’s structure. Much of this is associated with sentiment of the Monetarists with Friedman’s believe that the Fed can be ineffective or doing too much with monetary policy combined with Austrian beliefs such as those by Hayek that gold-backed asset currency is better than the current fiat system. One proposed change in policy in the Trump administration would be the repeal of the Dodd-Frank Act, regulating the financial markets after the Great Recession to stem risk of failure by regulating the financial industry. This would reduce regulations on the financial and banking sectors to allow them to engage in more activity, sometimes more risky. Combined with the possible implementation of a rule, would allow for more transparency and predictability of interest rates, which would have a greater impact on expectations.

    The other change being the change in power of the Fed to shift from the governors to the presidents of the Fed. It would allow for a more decentralized approach, giving each regional president more of a say in the policy enacted. While the presidents are appointed and selected from their own regional banks by a board, it is argued that elevating the presidents would remove an appointment from democracy.

    (I forgot to insert the links in my first submission)
    http://www.nytimes.com/2016/11/13/business/economy/trump-the-fed-yellen-gets-ready-for-reckoning.html?_r=0
    http://www.cnbc.com/2016/11/16/obscure-part-of-law-could-let-yellen-fischer-thwart-trump-on-reshaping-the-fed.html
    https://www.brookings.edu/testimonies/examining-federal-reserve-reform-proposals/

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