The idea of appointing a shadow Federal Reserve chair is rife with risk. Rather than undermining the credibility of the current chair, the prospect of such a move appears to be playing into the greater global reassessment of the dollar as the ultimate safe haven.
In addition, there is scant room for a near-term Fed reduction in its policy rate, and any opportunity could rapidly evaporate should inflation increase, as our estimate of the Fed’s reaction function below implies. For this reason, one can observe in near real time the perils of appointing a shadow Fed chair.
While shadow ministers are not uncommon in parliamentary systems of governance, such an appointment would cut against the grain of Fed independence and its institutional credibility that have evolved over the past half century.
The appointment of a shadow Fed chair has three primary shortcomings:
Erodes central bank credibility: Any move that reduces the independence of the Fed runs the risk of higher yields, a weaker dollar and volatility across asset classes. Once that genie is out of the bottle, the primary risk is that it dislodges inflation expectations, which are already under duress. In addition, the plunge in the value of the dollar against the euro on Wednesday, which came after a steady decline this year, was partially a function of the potential appointment of a Fed shadow chair as investors continue to question the credibility of dollar-denominated assets.
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Death by a thousand cuts: Once a shadow chair is appointed, it will then be open season on the views of the Fed chair in waiting. One should anticipate a torrent of analysis, criticisms and outright attacks on the views of an individual who would, assuming confirmation by the Senate, not take office for 11 months. The steady drip, drip, drip of criticism would almost surely undermine the appointee’s credibility well before taking office.
Institutional resistance: Appointing a Fed chair well before the current chair’s term ends runs the risk of stoking a display of institutional independence across the Federal Reserve system. It is easy to construct a scenario where tariffs send inflation higher while unemployment rises; the new chair, expected to reflect the interest rate preferences of the White House, would then be put in the most difficult of circumstances. A new chair bent on cutting rates may run into resistance from other central bankers who all have their own estimates of the optimal interest rate. The last thing a new Fed chair would want is to be outvoted on the Federal Open Market Committee soon after taking over. That would undermine the new chair’s credibility and that of the president, who made the appointment.
