MNI INTERVIEW: FOMC To Go Own Way If Chair Lacks Credibility

The heavy mantle of responsibility on the next Fed leader will guide him to set monetary policy independent of President Trump's influence, and should the chair fail to make a convincing case for a desired course of policy, the 11 other members of the rate-setting FOMC would vote according to their own judgement, former Cleveland Fed President Loretta Mester told MNI.

"We don't have a Fed chair who can just make a decision. The chair has to drive the consensus of the committee, and if the person in the seat can't make a credible case for whatever policy he or she wants to advocate for, then I expect people would dissent," Mester told MNI's Fedspeak podcast. 

"And I don't believe anybody coming into that job will just do something that he or she is told. The burden of being in charge of an institution that has such power and responsibility will wear on that person in a way that hopefully is a guardrail against doing things that aren't appropriate in terms of setting policy."  

Her comments come as Trump has intensified calls on the Fed to slash interest rates and threatened to oust Chair Jerome Powell, or appoint a "shadow chair" before his term is up in May. (See: MNI INTERVIEW: Powell Firing Would Set Off Legal Battle-Menand)

MARKET REACTION

"Trump is not the first president of the United States to comment on monetary policy, but the level and the persistence, and then the talk about firing him before his term ends, has a level that we haven't seen in quite a long time," Mester said. "Fed independence is at risk, and that's unfortunate, because independent monetary policy making is really one of the foundational tenants of effective policy making."  

Financial markets know well the detriment to the U.S. economy and the dollar of a tainted central bank, Mester said, noting longer term bond yields rose and stocks fell in response to Trump's attacks on Powell.

"Markets take some of this with a grain of salt, because we've seen these kinds of comments before," she said. 

But if the situation were to escalate, Mester said she expects bond investors to demand higher yields to compensate for potentially higher inflation and also "the risk that perhaps the U.S. fundamentals, including the fundamental of central bank independence, are not going to be sustained over time, and so it'll be more risky to take on U.S. debt." 

LONG-TERM RATES

The fundamentally different timelines on which the president and the central bank operate is the key reason to insulate the latter from political influence, she said. Political leaders have a bias to lower the cost of government debt, but by pursuing low rates, they risk getting higher inflation in the future, moving further away from the central bank's price stability mandate. 

Trump himself has said he wants lower longer-term interest rates, but setting short-term rates too low won't necessarily lead to that desired outcome, Mester said. 

"Expected inflation, inflation expectations and inflation risk premia – if you think inflation is higher and more variable under a new regime – goes into those long-term bond rates. So it isn't even clear to me that inappropriately setting rates too low will actually help that. And in fact anything that's a threat to the independence of the Fed could actually lead to higher long-term bond rates, not lower," she said.