SINGAPORE (Oct 17): Speculation is rising about an imminent nomination to replace Janet Yellen as chair of the Federal Reserve. None of the main candidates would push the Fed in a more dovish direction. Continuity is most likely, but there is the risk of a hawkish tilt if John Taylor is appointed.

The Federal Open Market Committee (FOMC) that votes on monetary policy is made up of the seven members of the Federal Reserve Board of Governors in Washington (which currently has three vacancies), plus the president of the New York Fed and a rotating selection of four from the other eleven regional Federal Reserve banks. All of the regional Fed presidents participate in the meeting, and submit their views to make up the “dot plot” of interest rate projections, but not all vote.

About half of the Fed officials have a PhD in economics. Having non-economists on the FOMC is useful in bringing a different perspective, but it is unlikely that someone with a background in law or financial markets is going to have much influence on the vote of a well-trained economist.

As such, Jerome Powell, Gary Cohn or Kevin Warsh would struggle to drive opinions. They might affect the Fed’s attitudes on financial regulation (which could have political appeal), but not monetary policy.

Like her predecessor Ben Bernanke, Chair Yellen was a highly-respected academic economist prior to joining the Fed. She might not be the best economist in her family (married to Nobel Prize winner George Akerlof) but there have been times when she has clearly led the Fed’s view – usually in a dovish direction.

John Taylor is an academic of similar stature, with a good chance of receiving the Nobel Prize for his rule on how central banks should set interest rates. If Taylor is chosen as Fed Chair then he could tilt it in a hawkish direction, especially if the nominations to fill existing vacancies on the Fed Board are sympathetic to his views.

The Taylor rule is a calculation of where interest rates should be, based on how far inflation and unemployment are away from target. Some members of Congress support a rule-based approach that would limit the flexibility of the Fed, which they see as having over-reached its mandate since the Global Financial Crisis (GFC). Incidentally, the Taylor rule does a good job in showing that the Fed ran policy too loose in the wake of the dot.com bubble bursting, which probably contributed to the excesses ahead of the GFC.

The bad news from a market point of view is that the Taylor rule is currently pointing to a much higher level of interest rates. There are different ways of formulating the calculation, but a standard approach would put the Fed Funds rate at about 3.5% - more than 2% above present levels. This should make Taylor an unlikely choice for a growth-oriented president.

The line of least resistance points to the reappointment of Yellen, as it is hard to imagine a credible candidate who would be more dovish. However, Yellen’s resistance to financial sector deregulation is unlikely to endear her to President Trump. As with many things related to this president, the decision is unpredictable, but of the main candidates only Taylor looks like a risk to financial markets.

Richard Jerram is Chief Economist at Bank of Singapore