But a darker branch could emanate from this path. Consider the possibility that the administration becomes enraged that they cannot remake the Fed. This may be the case, for instance, if the Fed deems it necessary to offset impending fiscal stimulus and the inflation it might bring with higher interest rates. Some Fed officials already see room for higher rates in a Republican-controlled government.
The administration, aided by a friendly U.S. Congress, might in this case pursue legislative options to bring the Fed more in control of the executive branch, thereby curtailing the Fed's independence. The central bank was made by congress, and can be unmade by congress. Indeed, the Fed will almost certainly face additional efforts to rein in its independence via a revival of "Audit the Fed" bills in any event. In the worst case scenario, the Fed as we know it could become a completely different organization that does not adhere to central banking best practices.
But what policies would such a Fed pursue? Consider the path that Trump does get to remake the Fed by either taking advantage of upcoming resignations of Board members or in the medium term by legislative action. Typically, we would think such an outcome would be inflationary. If the administration fears a monetary offset, it would pick pliable board members who are willing to hold rates low, thereby allowing the Fed to overshoot its current mandates. The future might then look like the 1970s.
Yet another direction is possible. The "Audit the Fed" movement generally believes monetary policy remains too loose. For example, the suggestion of forced application of a Taylor Rule, or even just requiring the Fed to explain deviations from the Taylor Rule, are a reaction to the persistently low interest rate policies pursued in the post-Great Recession world. If the administration continues to pursue this logic, it may be that a Trump Fed would be a so-called "hard money" Fed.
There are two potential challenges with a "hard money" Fed. The first is that it would remove financial accommodation too quickly. This does not seem likely in the near term; it would take until 2018 at the earliest until the Fed could be remade either through attrition or legislation.
The second challenge, however, is more disconcerting. Trump's characterization of the current economy as "false" suggests a sympathy for the Austrian school of economics, in which short-term monetary benefits are believed to come with longer-run costs. The "false" economy fosters asset price bubbles that pop and end in an even deeper recession than would otherwise be the case.
A Fed packed with Austrian economists would likely react slowly to a recession and resist extraordinary policies such as quantitative easing. They would also likely attempt to tighten policy soon after the recession ended. They would, in other words, tend toward a liquidationist approach that risks turning the Great Recession into another Great Depression.
Finally, note that regulatory policy — not monetary policy — faces more immediate impacts from the new administration. One of Trump's nominees would most likely serve in the currently vacant position of vice chair for supervision. This would give Trump the ability to exert influence on the regulatory environment facing the financial industry. That the nominee will likely possess a business-friendly attitude.
Bottom Line: There are three possible directions for monetary policy. The best outcome would be continuity, or a Fed that remains independent and follows current best practices supported by personnel chosen for their expertise. Alternatively, the Fed— either through personnel attrition or legislation — becomes politicized. That path leads to either a loose money Fed or a hard money Fed. The former sets the stage for inflation, the latter, deep, long, and painful liquidationist recessions. My expectation would be the former. In any case, Trump's first marks will be felt on regulatory rather than monetary policy.
This article was provided by Bloomberg News.