Federal Reserve Chair Janet Yellen’s inflation strategy may have a shelf life of about four months. After that, a gang of newcomers might have to decide what to do next.
Given such unknowns, central bank transitions are risky for investors. That’s one reason U.S. presidents have a long history of reappointing Fed chiefs. By early 2018, as many as three new governors and a vice chairman will have the power to decide whether they maintain Yellen’s strategy of gradually hiking into an inflation “mystery,” as she calls it. Yellen’s four-year term as chair ends in February, and an extension isn’t guaranteed.
“They will have to decide how much weight they put on this view that the Fed has” of inflation being temporarily low, said Torsten Slok, chief international economist at Deutsche Bank AG. “Do they believe the wolf is coming or will they say there is no wolf to worry about?”
The change in leadership at the top of the world’s most important central bank “is incredibly under-appreciated by financial markets,” he added.
President Donald Trump has said Yellen is under consideration for a second four-year term, though the White House is also reviewing at least six other candidates. Some, such as Stanford University economist John Taylor and former Fed Governor Kevin Warsh, have argued that monetary policy enjoys too much discretion and lacks a clear strategy. Today’s inflation debate, however, doesn’t really advantage rigid, model-based policy, or even presentations of certainty about what is happening in the economy.
“Most of the names being considered would offer little continuity with Yellen’s approach,” said Michael Feroli, chief U.S. economist at JP Morgan Chase & Co in New York. “For many of them, inflation theories may take precedence over the inflation data.”
Missed Goal
The Fed has missed its 2 percent inflation target for most of the past five years. Tightening labor market conditions in the past few years have helped lower the jobless rate to 4.4 percent in August, below the Fed’s 4.6 percent estimate of a rate that represents the full use of labor market resources.
The personal consumption expenditures price index, minus food and energy, averaged 1.6 percent during Yellen’s term. Future readings of the Fed’s preferred inflation gauge could be distorted by the effects of hurricanes. Nonetheless, U.S. central bankers on Wednesday presented an interest-rate path that suggests they will continue hiking despite the persistent inflation-target miss.
It’s a policy that incorporates aggressive assumptions about what isn’t really knowable at this time: what low rates of unemployment will eventually push up wages resulting in higher spending and more flexibility by companies to raise prices. It is a strategy that is also trying to balance assumptions about what interest rate the economy needs to prevent overheating of credit-sensitive sectors, such as financial markets, housing and investment. The last thing Fed officials want is another bubble.