Yellen is Not Toast After All!

Since our commentary on President Trump’s inclinations on Federal Reserve Board nominees [link], there  has been some additional news. Trump has signaled that he is open to nominating Yellen for a second four year term as Fed Chair. Previously we said that while that was unlikely, it was nevertheless a possible  outcome, and she made our shortlist. This outcome remains unlikely, despite having become more probable.  But we see her as perhaps his best choice, in terms of having a Chair that is both highly respected within  policymaking circles and more inclined to enact policies he would favor. In judging the probability of Yellen  being the next Chair, we must consider both the probability that Trump will want to renominate her and the  probability that she would accept. That probability has increased, but perhaps not to higher than 25%. So,  Yellen is probably not going to continue to be the Chair beyond February 2018. On the other hand, there  may not be anyone with a higher probability. 

Getting to Know You 

Trump ridiculed Yellen during the campaign and it appeared unlikely that Trump would reappoint her, based  on that rhetoric. Nevertheless, we took the possibility that Trump might renominate Yellen seriously, even if  it appeared unlikely. Now that Trump has met with Yellen, we suspect that he came away impressed. We  see a greater chance of her being renominated, on the basis of Trump’s latest remarks on her: “No, [she’s]  not toast…I like her, I respect her.” The Secretary of the Treasury, Steven Mnuchin, has met with her  weekly since assuming his position, as has been the historical practice. In an interview with the Financial  Times, he said: 

I meet weekly with her, we have very productive discussions, I think there’s a history of a relationship  between the Treasury and the Fed working together. I’ve been very pleased with that relationship, and  working with her to date, and it’s been very productive. Actually I was sitting in the President’s office  

when he was giving that Wall Street Journal interview, so I was there when those questions were  asked, and I’d make the same comments that he did. We are open-minded, and it’s too early to make  any decisions, but we’re open-minded. 

The Evolving Decision Dynamics in the Trump Administration 

Trump has walked back many of the policy pronouncements he made during the campaign as more moderate advisers have apparently become more dominant. His new view of Yellen may be part of this  unfolding dynamic. We argued earlier that Gary Cohn would likely exert a major influence on this decision.  And we continue to expect that he, along with Secretary Mnuchin, will play a central role in Fed  appointments, especially for the positions of Chair and Vice Chair. Frankly, we would be surprised if Yellen  didn’t at least get a spot on their shortlist of candidates for Chair. 

Why Is Yellen a Great Choice for Trump? 

We believe that Yellen would be a great choice for Trump, perhaps the ideal choice.

First, she appears to be pursuing outcomes for monetary policy that Trump should appreciate: Promoting  continued above-trend growth and maintaining monetary accommodation even though the economy is  already at full employment and on track to meet the 2% inflation objective. That’s what Trump wants:  above-trend growth that will lower the unemployment rate further and sustain strong employment growth. 

Second, he would also value (as would Cohn and Mnuchin) the likely positive reception that a Yellen  reappointment would receive from financial market participants. The only downside would be the reception  of Republicans in Congress, where Yellen is less popular, especially in the House. 

Third, she is always ready to move to a risk management mode when uncertainties arise—willing to take  out insurance against low-probability events with very adverse consequences. Any President is likely to  appreciate that instinct. 

But we have asserted that that Trump has an implicit edict: Academics need not apply. Wouldn’t Yellen run  afoul of that principle? With the ascension of Cohn’s influence, this edict may be weakening. Cohn has  surrounded himself with experts. So Cohn and Mnuchin may be able to push Trump to appoint a former academic. Plus, Yellen is generally known today more for her public service and role as Chair and Vice Chair  of the Fed than for being a former academic. The argument would simply be: Experience matters when  appointing the Fed Chair. 

None of this seal the deal for Yellen. Other candidates who have some of these same attributes will be  considered, and they may be perceived as more loyal and sympathetic to Trump and to broader Republican  policy objectives than Yellen. But her qualifications are strong enough that she will be given serious  consideration. 

But Can He Trust Her? 

Yellen likely disapproved of nearly every policy proposal Trump championed during his campaign, and  indeed since he has become President. Would Trump worry that she would be a thorn in his side? Of  course! She is after all a very progressive Democrat. Still, she would likely avoid commenting on specific  policy proposals that are outside the purview of the Fed. However, she would continue to advocate for  social justice, focused especially on the issue of income inequality. And she will hold firm on her views that  potential growth is 2% or lower; that there is a limit on how much Trump’s policies can raise long-run  growth, and therefore, tax cuts would not pay for themselves; and that monetary policy should lean against  any policies, including fiscal policies, that threaten to push the economy away from full employment and  price stability. 

But What Does Yellen Want? 

We suspect that Yellen, foremost, wants to go back home to California and a quieter life. Moreover, she  will be making a decision jointly with her husband, George Akerlof. Akerlof is one of the world’s foremost  economists and a Nobel Laureate. We understand he is in a cubicle at the IMF. (Maybe that is an  exaggeration.) But Akerlof will fare better at Berkeley than in Washington. Indeed, he even has a parking  space there—nearly as rare as a Nobel medal! 

But she will also need to weigh other considerations. Yellen may want to stay on for the achievement of  the dual mandate and the normalization of rates and the balance sheet. She may feel that she needs to  remain at the helm to counter threats to the Fed’s independence that she sees brewing in Congress. Indeed,  prior to accepting renomination, she would seek reassurance from Trump that he would strongly and  publicly support the independence of the Fed. 

The Downside for Yellen 

The obvious downside for Yellen is Trump. It’s hard to see why she would want to be associated with  Trump, given her broader political and economic views. I’d love to hear the conversation around her dinner table! Does she want the last chapter of her service at the Fed to be one where the economy may be more at the mercy of Trump than the Fed? Moreover, could the economy really be in such good shape two or four years from now as it is today? It would be easier to let that challenge pass to the next Chair. 

It Takes Two to Tango! 

In our earlier commentary, [link] we argued that the possibility that Yellen could be renominated should be  taken seriously. Trump just increased the probability of that outcome. But keep in mind that we are talking  about a joint probability—the probability that Trump will offer the reappointment to Yellen and the  probability that she would accept. 

The probability that Trump would renominate her has clearly risen, maybe even to close to 50%. But, in our  view, there is less than a 50% probability she would accept. So that leaves the probability of Yellen being  the next Chair not far from one in four, in our view. So she probably will not continue being Chair, but at  the moment there doesn’t appear to be anyone else with a higher probability. 

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