A 'Shadow' Fed Chair Won't Work for Trump

Even if the tactic moved interest rates, Trump would not be able to stimulate his way out of economic problems.

Dear readers,

In 2018, Donald Trump made Jerome Powell the chairman of the Federal Reserve, and as tends to happen with Trump’s appointments and hires, Trump quickly grew dissatisfied with the way Powell was doing his job. Powell was raising interest rates, and Trump had a problem with that. Powell wasn’t raising them all that high, mind you; short-term rates rose to about 2.5% by the end of 2018. This move (a continuation of policy the Fed started when Barack Obama was president and Janet Yellen was Fed chair) reflected that the economy was strong and no longer needed the stimulation the Fed had provided for a long time in the wake of the global financial crisis. Nonetheless, Trump —a self-proclaimed “low-interest rate guy” — thought 2.5% was too high, and that his political fortunes would be better served by lower rates.

Trump complained loudly about the Fed, and he eventually got his way. The bank stopped raising rates at the end of 2018 and eventually cut them a bit in the later part of 2019, in what it termed a “mid-cycle adjustment.” It’s not clear that Trump’s complaining and the policy turn were related — a major financial market hiccup at the end of 2018 seemed to be more motivating for the bank — but it’s clear that one of the lessons Trump took from the experience was that central bank independence is bad and he would like to have more control over monetary policy if he becomes president again. Indeed, he’s said as much explicitly — “the president should at least have a say” over Fed decisions, he declared in August.

This week, one of Trump’s top economic advisers — financier Scott Bessent, a possible Treasury Secretary in a second Trump administration who holds the unlikely Republican credentials of being an openly gay protégé of George Soros — told Barron’s he has an idea about how to achieve that. While Powell’s term as Fed chair runs through early 2026, Bessent says Trump should create a “shadow” Fed chair by having the Republican-controlled Senate confirm Powell’s replacement in early 2025, well in advance of his term’s end. The idea is that because the Fed operates in large part through forward guidance — influencing long-term interest rates not just by setting today’s short-term rates but by telling market participants how it intends to set rates in the future — a designated future chair could influence monetary policy in 2025, simply by saying what he or she intends to do once ensconced in the chairmanship in 2026.

Scott Bessent speaks at the National Conservative Conference in Washington D.C., Wednesday, July 10, 2024. (Photo by Dominic Gwinn / Middle East Images / Middle East Images via AFP)

Though this idea is unnerving advocates of central bank independence, I think it just wouldn’t work — or at least it wouldn’t work in a way that would be helpful to Trump.

The first problem with this plan is figuring out who should be the shadow chair. One assumes that Trump’s problem with the Fed will again be that he would like it to set interest rates lower. But traditional Republican candidates to run the Fed are monetary hawks. Someone like John Taylor or Kevin Warsh (who were on Trump’s short list for Fed chair in 2017) is likely to want fewer rate cuts than Powell. This is why Trump ended up nominating Powell in the first place — Powell was the most dovish available Republican with typical credentials to run the Fed — and it’s also why, once Trump became dissatisfied with Powell, he kept trying to stack the Fed board not with normal Team-Red monetary policy figures like Warsh or Taylor, but with total hacks like Steve Moore, Herman Cain, and Judy Shelton.

Cain is now dead. Trump could pick Moore or Shelton (or someone else like them) as a shadow Fed chair. But last time around, Moore and Shelton faced significant Republican opposition, which is why Trump was unable to get them confirmed to seats on the Federal Reserve Board even though his party held a Senate majority. A lot of Republicans are not “low-interest rate guys” and do not share Trump’s unconditional enthusiasm for easy money.

Perhaps this time Republicans will hold a larger Senate majority and Trump will be able to get whoever he wants confirmed, and confirmed well in advance of the Fed chairmanship even being open to fill. But then there is still the problem of how the shadow chair is actually supposed to produce a monetary environment that makes Trump happy. There are major obstacles.

The main one is that the Fed chair does not make monetary policy — the twelve-member Federal Open Market Committee does, and it consists of all seven members of the Federal Reserve Board, the president of the Federal Reserve Bank of New York, and (on a rotating basis) four of the other 11 regional Fed bank presidents. Replacing the Fed chair does not create a new FOMC majority with a changed view on policy, and Trump will not have the ability to sharply remake the FOMC as a whole — five of the seven sitting FRB members are serving terms beyond the end of the next presidential term in 2028, and presidents don’t control who gets to run regional Fed banks.

As such, the installation of a shadow chair with views that break with both the sitting chair he or she would replace and the continuing members of the FOMC he or she would serve with is less likely to produce lower interest rates, and more likely to produce uncertainty about the future track of interest rates. More uncertainty about future monetary policy should increase the risk premium associated with long-term fixed-rate debt¹ and might actually cause politically important interest rates (like mortgage rates) to go up.

Finally, there is the problem of what happens if the shadow chair approach does work as intended, bringing down long-term interest rates and causing as early as mid-2025 more monetary ease than Powell himself might intend to produce. The economy is already overstimulated due to high budget deficits — a major reason why short-term interest rates have had to go up to the 5% range recently is that the inappropriately large federal budget deficit has fueled inflation, and countervailing tight monetary policy has been needed to suppress demand and allow the economy to cool. If Trump succeeds in forcing an inappropriate level of monetary stimulus — and he combines that success with his declared intention to further cut taxes and grow the budget deficit² — then inflation will ensue. In other words, if Trump plays stupid games with the Fed, he stands to win a stupid prize: a consumer price spike of the sort that has caused so much political trouble for Democrats over the course of the Biden administration.

This is a problem not just with the shadow Fed chair gambit but with Trump’s overall intended approach to economic policy. He appears to believe that presidents can juke monetary policy for their short-term political gain: cut interest rates, make it easier for consumers to spend and businesses to invest, and everyone becomes happier. Sometimes this is true — it was true in 2018 and 2019, for example. But all the slack in the economy from the aftermath of the Great Recession is now gone, and as we’ve all seen, too much money sloshing around in this economy tends to mean shortages and high prices, which make consumers mad, not glad. Trump and his voters seem convinced he’ll be able to recreate the economic conditions that prevailed under his presidency before COVID, but if he tries to run the same plays as back then, he’s likely to end up with spiking inflation and sagging approval ratings.

And that makes me wonder exactly what Bessent is up to with this suggestion. Is he floating this idea because he, himself, would like to be shadow Fed chair in 2025 and the actual Fed chair in 2026? He’d certainly be more qualified for the job than Steve Moore or Judy Shelton. But this strikes me as a pretty grim job opportunity, since it is impossible to use monetary policy to recreate the economic conditions of 2019. If I were him, I’d be much more interested in running the Treasury Department.

Very seriously,

Josh

1. In general, long-term interest rates are higher than short-term interest rates, and one reason why is that issuers of long-term debt face more risk from changes in the future interest rate environment than issuers of short-term debt do. If future Fed policy becomes more uncertain, then issuers of long-term debt will demand higher rates to compensate them for the greater risk they are taking on related to future changes in the interest rate environment. That would tend to mean higher rates on long-term fixed rate debt, such as mortgages.

2. Perhaps the most interesting news out of Bessent’s conversation with Barron’s isn’t about monetary policy at all, but about trade policy. One of the main ways Trump says he intends to avoid exploding the budget deficit is by imposing a huge, universal tariff on imports of 10% or perhaps 20%. Barron’s says Bessent thinks this is more of a “negotiating position” than a policy proposal. The tariffs are a bad idea, so on balance it would be a good thing if Trump is bluffing here — but if he is bluffing, then his policy agenda is even more deficit-busting and inflationary than it looks, meaning that if Trump forces a dovish turn at the Fed, that turn is especially likely to blow up in his face as a shock to consumer prices.