Turnover at Federal Reserve adds uncertainty to interest rate and QE3 promises


The sun rises to the east of the Federal Reserve building in Washington. Half of the Fed’s powerful rate-setting committee could leave as the withdrawal of its stimulus program looms. (Jonathan Ernst/Reuters)
September 5, 2013

The Federal Reserve is facing significant turnover among top officials at a time when it is trying to craft a long-term strategy for winding down its support for the nation’s economy.

The looming departure of Fed Chairman Ben S. Bernanke when his term ends in January has garnered the most attention on Wall Street and in Washington. But as much as half of the central bank’s powerful policy-setting committee could also leave next year — making it the biggest transition at the Fed since before the recession.

The policy committee steers the nation’s economy by setting interest rates that determine what businesses and consumers pay for loans. The personnel changes have heightened the uncertainty surrounding the Fed’s next moves. That’s because one of the main ways the central bank has tried to bolster the economy now is by promising to act in the future.

Fed officials say they won’t stop buying long-term bonds intended to bolster the recovery until the unemployment rate hits 7 percent. They also vowed to keep short-term interest rates low, at least until the jobless rate hits 6.5 percent or inflation rises above 2.5 percent.

But by the time those criteria are met, a new cast of characters could be calling the shots at the central bank.

“It’s a legitimate question to ask: Are those messages that the Fed has sent over the past several months correct?” said Roberto Perli, head of monetary policy research at Cornerstone Macro. “The answer is, it depends.”

Economists do not expect the newest members of the Fed to scrap those plans entirely. But even small shifts in policy can have outsize implications for the markets and the economy. U.S. stocks have been on a roller coaster since the Fed broached the idea of scaling back its bond purchases later this year. Investors are obsessed with when it will begin — September or December? — and the size of the reduction.

The turmoil on Wall Street is trickling into the real economy. Mortgage rates have steadily climbed amid a sell-off in the bond market, and there are signs that the increase could be slowing the housing recovery.

For now, the Fed believes that the benefits of its stimulus programs outweigh the costs. But a vocal minority within the institution has grown increasingly uncomfortable with the trade-off. At its most recent meeting, the Fed discussed altering the conditions it set for raising interest rates. Although officials made no changes, the debate is likely to be taken up again after the Fed’s new members arrive.

“A different set of people on the Fed could have a different view on what the appropriate unemployment rate is,” said Nigel Gault, co-chief economist at the Parthenon Group. “The Fed can change its mind.”

One of the leading candidates to replace Bernanke is Janet Yellen, vice chair of the Fed and a stalwart defender of its existing policies. The other is former Treasury secretary Lawrence H. Summers, who has carefully guarded his views on monetary policy.

President Obama has said he will choose a chairman this fall. But his administration has not focused on finding candidates to fill the other vacancies. Elizabeth Duke, a Fed governor, stepped down at the end of August, and Sarah Bloom Raskin, also a Fed governor, has been nominated to be deputy treasury secretary. Governor Jerome Powell’s term ends in January, although he could continue serving if no replacement is named. And Yellen is not expected to stick around if she does not land the top job.

Finally, Cleveland Fed President Sandra Pianalto will retire early next year — just as she is slated to rotate onto the central bank’s policy-setting committee. Her successor will be named by the bank’s board of directors, which said a decision will be made in early 2014.

All told, at least four new people — and as many as six — will be on the Fed’s 12-member policy committee next year.

“It takes time for markets to become comfortable in the sense that they can understand — or think they can understand — what the M.O. of particular central bank leadership is all about,” said Mark Spindel, founder of Potomac River Capital.

In some ways, the changes are part of the natural evolution of the Fed as it shifts out of crisis mode. The last time the central bank’s leadership underwent such significant change was in 2006, just before the nation’s financial system began to crack. Bernanke has led the institution through one of the most perilous times in economic history, and Obama acknowledged that he has “stayed a lot longer than he wanted or he was supposed to.”

Duke echoed that sentiment in an interview with the Virginian-Pilot, saying she is ready for a break.

“It seems like it’s been just one huge decision after another,” she told the newspaper. “It’s been pretty stressful all the way through.”

However, there is still one important task facing the Bernanke Fed: taking the first step toward allowing the economy to stand on its own.

“I think the biggest gift that Bernanke could give the next chairman is to start the process of tapering” Fed stimulus, said Diane Swonk, chief economist at Mesirow Financial. “That would set the stage for continuity of his policies.”

Ylan Q. Mui is a financial reporter at The Washington Post covering the Federal Reserve and the economy.
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