From Fed candidates, the central bank needs to change

Unemployment is at a decade low, the American economy is growing, and inflation is nowhere in sight, yet for two leading candidates to head the Federal Reserve, the central bank needs shaking up. The Fed is credited by most economists for its rapid response to the 2008 financial crisis. Under Chair Janet Yellen whose term expires next year, it has been able to shift into post-crisis mode, ceasing to add to its balance sheet and embarking on a series of rate hikes that will take interest rates back to “normal”.

For former Wall Street banker Kevin Warsh, who served as a Fed governor at the time of the financial crisis, the economic recovery is characterised by bloated central bank balance sheets, financial risks, and a hidebound institution that needs new approaches.

“We should not allow a failure of imagination, a failure of courage,” to impede changes to how the Fed is run, Warsh said in remarks at the Hoover Institution, an intellectual home of conservative economics where he is a visiting fellow.

While he did not refer to a potential candidacy for the Fed Chair job, Warsh’s speech struck some in the audience as an audition.

Warsh and Stanford University economics professor John Taylor have emerged as potential frontrunners to succeed Yellen whose term ends in February 2018.

Warsh, a Wall Street lawyer by training rather than one of the Phd economists who have come to dominate monetary policy in recent years, called for “fresh air from the real side of the economy, fresh air from the markets,” in revamping the Fed.

He says the central bank has left the public confused, lacks a long-term strategy, and is too beholden to short-term stock market and other events.

Warsh, who was consulted frequently by former chair Ben Bernanke when at the Fed, was speaking at the Hoover Institution, a centre of conservative thinking on monetary policy that has in recent years tried to amp up its profile in the Washington policy debate. Hoover is also Taylor’s intellectual base. Taylor is a favourite among Republicans who feel the Fed should be held closely to a formula, a “Taylor rule”, for setting interest rates and give up some of the discretion policymakers currently enjoy.

The list of possible chairs is a long one for a president who has surrounded himself with a not always coherent set of economic advisers — from trade sceptics and gold standard advocates to Wall Street insiders.

At this point Trump has not indicated whether he thinks the Fed needs fundamental reform.