Stanley Fischer, the vice chair of the Federal Reserve Board of Governors, announced today that he is stepping down. The seven-person board already has three vacant seats, so Fischer’s departure will add a fourth. That means President Trump will have significant ability to reshape the Federal Reserve even before Chair Janet Yellen’s term expires next year.
That reshaping could be much more important for bank regulation than for job growth and inflation.
Fed nominations have not traditionally been the subject of an enormous amount of political scrutiny (Barack Obama let several vacancies linger for years at the beginning of his term), but the Fed is a critically important institution both for regulation of the financial services industry and for the conduct of the broader economy. The Trump administration has taken a great deal of pride in the continued job growth over the course of 2017, but the reality is that the pace of growth appears to have somewhat slowed down relative to where it was in 2016.
That slowdown, in turn, is heavily influenced by the attitude of the Federal Reserve, where the predominant view seems to be that the economy is operating at close to full employment and that a slowdown in job growth is warranted. For Trump to have a chance at delivering on his aspirations, he almost certainly needs a Fed that’s less hawkish on inflation. But so far his inclinations on Fed appointments seem to drive almost entirely toward bank deregulation with scant attention to monetary issues.
Trump has a lot of seats to fill
Two of the four Fed vacancies are openings that Trump inherited from the end of the Obama administration, when GOP control of the Senate made it nearly impossible to fill jobs where vacancies didn’t create an emergency situation.
The third vacancy stems from the resignation earlier this year of Dan Tarullo, who’d served as the Fed’s top bank regulator. In his place, Trump has nominated Randy Quarles, who is known as favoring a lighter touch on bank regulation, particularly on the crucial issue of how much risky borrowing banks should be allowed to engage in. There’s been considerable speculation that Marvin Goodfriend, a Carnegie Mellon professor and former Fed staff economist, will be tapped for another opening, but he has not been officially nominated and Quarles has not been confirmed. The other vacancy has no rumored candidate, and Fischer’s resignation from the high-profile vice chair job creates yet another opening.
The Fed Board collectively dominates the Open Market Committee that sets monetary policy. The Board is also influential in selecting board members of the regional Federal Reserve banks, which, in turn, select the regional Fed presidents who occupy other seats on the Open Market Committee. All of which is to say that while vacancies aren’t a national crisis — the Fed operates just fine with a skeleton Board and a robust staff — they are a big opportunity to reshape policy.
The Fed is slowing the economy
Over the past two years, the Fed itself has been slowly but surely waging war on the phantom menace of inflation, raising interest rates at a gradual pace as the unemployment rate falls even though actual inflation remains consistently below the Fed’s 2 percent target level. This reflects an apparent near-consensus on the Fed Board and among Fed staff that moderating the pace of job growth in order to ensure that there’s no possibility of any future bout of inflation is a higher priority than trying to get people who’ve left the labor force off the sidelines and back to work.
Neel Kashkari, president of the Minneapolis Federal Reserve bank, is sharply critical of this approach, viewing it as akin to being frightened by a “ghost story”.
There’s no sign that Quarles agrees with Kashkari’s criticism, however, and Goodfriend also appears to be a monetary policy hawk who was critical of the Fed’s quantitative easing programs.
Trump himself seems totally unaware that a more growth-oriented Federal Reserve is even an option.
In an interview with the Wall Street Journal, Trump contemplates two possibilities for when Yellen’s term expires. One is keeping her in office, because “I’d like to see rates stay low” and “she’s historically been a low-interest-rate person.” He also considers elevating his National Economic Council Chair Gary Cohn, whom he says he has “great respect” for and thinks is doing “a very good job” in his current role, but under whose watch he believes “interest rates will be moving up” at a somewhat faster pace.
A deregulatory Fed
Rather than pursuing growth-oriented monetary policy, Trump’s main agenda at the Fed appears to be the same as his main agenda in most other areas of economic policy: adopting a business-friendly light touch to regulation.
Cohn, Trump’s chief economic advisor, used to be a top executive at Goldman Sachs and thinks that the federal government went too far in regulating banks after the financial crisis. Trump’s treasury secretary also worked at Goldman Sachs before becoming a hedge fund guy and also thinks the federal government went too far in regulating banks after the financial crisis. His appointments to the Securities and Exchange Commission and other regulatory agencies share this generally deregulatory perspective. So does Quarles, whom Trump has tapped to be the top bank regulator at the Fed.
Lots of different agencies own different pieces of the bank regulation puzzle, but an area in which the Fed has been particularly central under the leadership of Yellen and Tarullo is the regulation of bank capital. The issue here is essentially how much bank investment can be financed with borrowed money — with more borrowing being more profitable when it works out, but riskier when it doesn’t. Since banks, unlike normal businesses, tend to get bailed out if they fail spectacularly, there is an incentive to take on excessive amounts of risk. Which is where regulation comes in.
The Trump administration’s main thrust on banking policy has been hostility to all this, and as Fed vacancies pile up, they are more and more likely to get their way in terms of letting banks engage in riskier behavior.