Time for Democrats to panic about the Fed

The Federal Reserve is one of the most powerful government entities in existence, with far-reaching abilities to shape the U.S. economy. The ideological and partisan disagreements over how it should conduct policy are wide and deep. Yet its staffing is usually carried out with with little political fanfare.

Now that we're in the era of President Trump, it's time for the Democrats to pick a fight.

The precipitating event here was last week's announcement that Daniel Tarullo would resign from the Federal Reserve's Board of Governors, probably sometime in April. Moreover, two spots on the seven-person board are already open. When Tarullo departs, there will be three vacancies.

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Like Supreme Court justices or Cabinet secretaries, members of the Fed's Board of Governors are appointed by the president and confirmed by the Senate. So it will fall to President Trump and the Republican majority in the Senate to fill those three spots, and quite possibly remake the Fed as an institution in the process.

There are two big issues that Democrats, their supporters, and the activists who hold the party to account need to consider here.

The first is monetary policy: deciding where to set interest rates. When the Fed thinks the economy isn't creating enough jobs, it cuts interest rates. When it's worried inflation may get out of control, it raises them. How Fed officials approach that trade-off carries enormous consequences. Since around 1980, the Fed has aggressively guarded against rises in inflation, but has been relatively lackadaisical about juicing the economy. Decades of stagnant wages, skyrocketing inequality, and increasing job insecurity resulted — but there have also been bigger payouts to corporate shareholders, and higher profits for big finance in particular.

Perversely, Republicans generally accuse the Fed of not being nearly hawkish enough about inflation, while repeatedly (and incorrectly) predicting sky-high inflation. Granted, most of this is in the House. But there are inflationista senators like Rand Paul as well, and the two chambers draw from the same overall ideological networks.

Furthermore, the Board of Governors isn't the only batch of Fed officials who vote on how to set interest rates. There are also five seats filled by a rotating selection of regional Fed bank presidents, for a total of 12 votes. These five individuals are deeply enmeshed in the financial industry, further biasing Fed policy towards inflation hawkery.

Tarullo himself was known for being relatively dovish on inflation, and for prioritizing stronger job growth. But it's pretty clear at this point that Trump has no idea what he thinks of monetary policy and will go whichever way the wind blows. So the GOP may have a chance to fill three of the board's seven seats, massively tilting monetary policy in a much more anti-worker direction.

The second matter to consider is the Fed's role as one of the most important financial regulators among the government agencies.

Tarullo himself was the acting chairman of the Board of Governors' Committee on Supervision and Regulation, and the Fed's point man for setting rules to rein in Wall Street. He garnered a reputation for firmly enforcing the new safeguards put in place following the 2008 financial crisis, and for zealously enforcing "stress tests" on the big banks to make sure their books weren't unstable.

Tarullo also pushed for stronger capital requirements, a particularly important form of regulation that lowers a bank's risk of collapse, and that can be used to cut banks down to size. What his replacement makes of capital requirements will be especially telling, since some members of the GOP seem to favor (sort of) tougher requirements, while key members of Trump's economic team argue the requirements are too stringent already.

Tarullo said he thought the "core principles" for financial regulation that Trump outlined in a recent executive order were a "perfectly good starting point." But the wording of the order is so vague that it's effectively meaningless. So Tarullo was probably just being polite. As for Wall Street itself, one anonymous bank executive told Reuters that "the industry is relieved the Tarullo era is over."

Now, the Fed is much more an enforcer of regulations than a designer of them. That latter role falls to international agreements and legislation like Dodd-Frank. And Tarullo sounds confident that Dodd-Frank and the rest of the regulatory structure he helped put in place won't be overturned; the Democrats have more than enough votes to filibuster any regulatory rollback in the Senate. But the Fed also has some discretion in rulemaking — it sets higher capital requirements for the biggest banks, for example — and there is always the question of how devoted the agency is to enforcement. "Regulations mandated by law cannot be erased by the Fed, but the central bank has amply demonstrated in recent decades that indifferent enforcement serves the same purpose," as The New York Times recently observed.

To top it all off, whoever Trump and the GOP pick to fill these three positions will serve for 14 years. The consequences of those choices will last long after the Trump administration and the current congressional majorities have departed.

In short, the nominees deserve the utmost scrutiny. Democrats should grill them about their philosophy towards interest rates, the state of the economy, and financial regulations. Another good subject is how to pop bubbles: Unfortunately, the Fed leans more heavily on high interest rates, rather than tougher regulations, to control financial instability. Outside of Congress, the prominence of this fight will likely be raised by some dedicated activists, which is as it should be.

In fact, the two vacancies that preceded Tarullo were left empty by a combination of neglect by the Obama administration and the knowledge that Senate Republicans would surely block any nominee he put forward. When the GOP refused for a year to vote on Obama's nominee to the Supreme Court, the move was considered unprecedented. But the vacancies at the Fed have been there for multiple years.

So if the Democrats are the least bit uncomfortable with any of Trump's nominees, they should not hesitate to launch a full-scale political brawl — including use of the filibuster. The stakes are too high to do otherwise.