The Fed Isn’t the Tax Cut’s Enemy

Officials are open to the possibility that the tax cut will raise the economy’s potential growth rate, although it isn’t their base case

conventional wisdom is that this is the wrong time for Republicans to cut taxes by $1.4 trillion over the next decade. The fiscal stimulus will overheat the economy and force the Federal Reserve to slow it down by raising interest rates more aggressively.

inflation is still too low, and that completely changes the equation: It suggests overheating is to be welcomed, not resisted.

officials are open to the possibility that the tax cut will raise the economy’s potential growth rate, which means faster growth wouldn’t necessarily lead to more inflation.

.. Ms. Yellen and her likely successor, Fed governor Jerome Powell, aren’t yet the party poopers many supply-side tax cut advocates feared.

.. [Larry Kudlow: ] The real test, he said, is how the Fed reacts if growth tops 3%

.. By 2020 Fed officials expect their benchmark federal-funds rate to reach 3.1%, which would be above the 2.8% they expect to prevail in a fully-employed economy growing normally

.. Ms. Yellen made it clear she didn’t agree with Mr. Trump and Treasury Secretary Steven Mnuchin that the tax cut would pay for itself, and warned it may be “taking what is already a significant [debt] problem and making it worse.”

Mnuchin Gets His Man

Steven Mnuchin. The Treasury Secretary lobbied hard for Mr. Powell on grounds that he was more open to Administration influence than the other leading candidates. This may be unfair to Mr. Powell, but it does raise questions about Mr. Powell’s independence and capacity for the job.

 .. He has few enemies, but he has left barely a policy footprint. His speeches are notable for endorsing whatever official Fed policy was at the time. He’s never dissented at the Open Market Committee (FOMC), which can be seen as loyalty to the chairman or a lack of personal conviction. This is especially notable in a period when other governors and regional bank presidents opine on everything.
.. This suggests that Mr. Powell’s views reflect those of the monetary status quo under current Chair Janet Yellen, and perhaps this is what Messrs. Mnuchin and Trump want. But in that case Mr. Trump should have continued with Ms. Yellen, who at least has been in charge. Mr. Powell will have to establish his authority with the other FOMC Members and the Fed staff, which is dominated by economists with a monetary policy model that requires a firm hand to supersede.

One certainty is that the next four years will be more volatile, especially if growth accelerates, interest rates rise and as the Fed shrinks its balance sheet. Mr. Powell has some experience in domestic financial markets but not in international currency and emerging markets. The combination of Mr. Powell at the Fed and Mr. Mnuchin at Treasury isn’t exactly the financial equivalent of SEAL Team 6.

Who Will Be Trump’s Pick to Lead the Fed? We Asked Experts to Rate the Odds

Ms. Yellen has a possibility of being renominated, according to this consensus, but it is only 22 percent; experts think that Kevin Warsh, a former Fed governor with deep Republican ties, has a slightly better chance at 23 percent.

.. The case for renominating Ms. Yellen is straightforward.

She has presided over four years of steady economic expansion and rising financial markets. She moved cautiously toward raising interest rates even though the economy seemed to be approaching full employment. By contrast, some more conservative contenders for the job have indicated they want to raise rates more quickly, which could endanger the economy as President Trump approaches midterm elections in 2018 and a potential re-election battle in 2020.

.. Moreover, as President Trump dabbles in making deals with Democrats, reappointing Ms. Yellen could serve as an expression of good faith to Democratic senators. As administration officials focus on tax legislation and other priorities on Capitol Hill, it might be helpful to them to nominate someone who might sail through confirmation, rather than demand a bruising, time-consuming battle.

.. The case against Ms. Yellen is similarly straightforward: She is a liberal economist in a government dominated by conservatives. She is a cerebral academic serving during the presidency of a bombastic businessman. And she is a staunch defender of the work the Fed and other bank regulators have done to try to limit risk in the financial system — including in a high-profile speech last month — amid an administration focused on deregulation.

Kevin Warsh: well connected, but with baggage

He has a law degree, but no advanced degree in economics.

.. Mr. Warsh has been a skeptic of the Fed’s efforts to boost the economy through quantitative easing and has advocated raising interest rates more quickly. He also has a regulatory philosophy more in line with the administration’s.

.. Mr. Warsh’s father-in-law is Ronald Lauder, of the Estée Lauder cosmetics fortune, a major Republican donor with longstanding ties to Mr. Trump.

.. If Mr. Warsh is nominated, expect significant blowback during the confirmation process from Democrats, who are likely to accuse the 47-year-old Mr. Warsh of being underqualified, of being responsible for the 2008 bank bailouts and inclined to regulate banks too lightly now, and of being too overtly political for the traditionally nonpartisan Fed chairmanship.

.. Democrats would be eager to criticize the administration for naming a recent top executive at Goldman Sachs to be the nation’s most powerful financial regulator. Some populist Republicans might join them.
.. Foremost among them are several of the names we would probably be hearing about if a conventional Republican president were in the White House
.. John B. Taylor is a respected economist at Stanford who worked in the George W. Bush administration and has been an influential voice among congressional Republicans who want to see the Fed bound by stricter rules governing its actions.

Glenn Hubbard was a top economic adviser to Mr. Bush who is dean of Columbia Business School.

Larry Lindsey was another top adviser to Mr. Bush and a former Fed governor with an economics doctorate from Harvard.

.. Their doctorates and affiliations with top universities may actually be downsides in an administration that has shown disdain for academic expertise.

.. other names has emerged in various reports, including the F.D.I.C. vice chairman Thomas Hoenig and John Allison