Donald Trump will replace Janet Yellen with a DOVE in 2018
Some have suggested that when Janet Yellen’s term as Federal Reserve chair expires in 2018 then Donald Trump will try to replace her with a more “hawkish” chairman. Some even has suggested that he could try to re-introduce the gold standard and appoint the king of monetary policy rules John Taylor as new Fed chairman.
I, however, believe that is completely wrong. Donald Trump doesn’t care about the Gold Standard (luckily) and certainly he does not care about a rule-based monetary policy.
The fact is that Trump’s entire policy agenda is inflationary. On the supply side his anti-immigration stance will push up US labour cost and this protectionist agenda will push up import prices.
On the demand side his call for underfunded tax cuts and massive government infrastructure investments also increase inflationary pressures.
So if unchecked (should write un-offset by the Fed?) Trump’s economic policy agenda will push inflation up. However, Trump does not – yet – control monetary policy and if the Federal Reserve is serious about it’s 2% inflation target it sooner or later will have to offset the Trumpflationary policies by hiking interest rates potentially aggressively and allow the dollar to strengthen significantly.
I have argued (see here and here) that initially the Federal Reserve will welcome a “fiscal boost” to support aggregate demand as the Fed for some odd reason is not willing to use monetary policy to hit the 2% inflation target. However, the alliance between the Trump administration and the Federal Reserve could be short-lived if inflation expectations really start to take off.
So in a situation where the Fed moves to hike interest rates more aggressively – for example in the second half of 2017 or in early 2018 it will become clear even to Trump that the Fed is “undermining” his promise of doubling US growth and “create millions of jobs”.
That could very well create a conflict between the Fed and the Trump administration and it is very likely that Trump will accuse Yellen of have too tight a monetary policy. Furthermore, with mid-term elections due in 2018 the Republicans in the Senate and the House are unlikely to be cheering for a “growth killing” tightening of monetary policy.
As I have repeated on the social media over the last couple days – the GOP is (deflationary) “Austrians” when they are in opposition and (inflationary) “Keynesians” when they are in power – they never really favour monetarist and rule-based policies.
After all it was Richard Nixon who famously said “we are all keynesians now” – or rather this is how Milton Friedman interpreted what Nixon said.
Nixon of course had the utterly failed Fed chair Arthur Burns (see more on Burns and Nixon here) to do the dirty work of easing monetary policy when monetary policy already was far too easing.
If Trump reminds me of any US president it is Nixon. So why should we believe Trump would replace Janet Yellen with John Taylor when he can find his own Arthur Burns to help him support his agenda with overly easy monetary policy ahead of the 2020 presidential elections?
If this hypothesis just has a small probability of being right then the market certainly is right is to price in higher inflation during a Trump presidency. I certainly hope I am totally wrong.
PS for a discussion of Nixon and Burns’ relationship seen Burton Abrams very good (and scary) paper How Richard Nixon Pressured Arthur Burns: Evidence From the Nixon Tapes.
PPS Paul Krugman once called for Ben Bernanke to show up for a FOMC press conference in a Hawaii shirt to signal that he would be “irresponsible” and thereby push inflation expectations up and lift interest rates from the ZLB. Maybe Trump is that Hawaiian shirt.