By Howard Schneider
WASHINGTON (Reuters) - Change at the Federal Reserve could come quickly with President-elect Donald Trump's team pledging to promptly fill high-level central bank jobs and roll out a tax and fiscal plan that could rewrite policymakers' core economic assumptions.
Fed officials already say their plan to gradually increase interest rates may need to be accelerated to accommodate the new administration's economic proposals, which could push inflation higher.
The concerns for Fed Chair Janet Yellen are broader as she faces a 14-month window to preserve her legacy and try to ensure the central bank's independence in the face of a possible four or more Trump appointees to its seven-member Board of Governors.
Yellen's term as Fed chief expires in February 2018, and Trump is likely to name a successor in synch with his desire to cut financial regulation, lower corporate taxes, reorder fiscal policy, and possibly impose some of the constraints on the Fed that Republicans in Congress have long advocated.
Yellen, 70, a ranking Fed official for the past 12 years and the top U.S. central banker since 2014, laid out a long list of concerns during recent questioning before Congress: that any fiscal boost not blow up the deficit and be tailored to improve growth and productivity; that the regulations crafted after the 2007-2009 financial crisis not be trashed; that the Fed not be hamstrung by policy rules or political pressure.
"There is clear evidence of better outcomes in countries where central banks can take the long view, are not subject to short-term political pressures," Yellen said in her testimony. "Sometimes central banks need to do things that are not immediately popular."
Fed officials would not comment on whether Trump and Yellen have spoken, or describe the contact so far between the central bank and the Republican businessman's transition team. Trump transition officials could not be reached for comment.
DIFFERENT OPERATING PHILOSOPHY
It remains unclear how deep a stamp Trump wants to put on the Fed, or what he feels about issues like central bank independence that are fundamental to Yellen and her peers.
Trump's sharp comments about Yellen during the presidential campaign, when he accused her of setting monetary policy to help Democrats, rattled Fed officials who felt he had crossed a line. But it is not known whether he'll be content to merely change personnel - Fed Vice Chair Stanley Fischer's term also runs out in 2018 - or whether he hopes to infuse the central bank with a different operating philosophy altogether.
Congressional Republicans are expected to push legislation forcing more oversight of the central bank, possibly tying it to a monetary policy rule that more mechanically sets rates. Among the candidates mentioned as Yellen's possible replacement is Stanford University economics professor John Taylor, whose "Taylor Rule" is often used in analysis and as a reference point in debate over the usefulness of rules in general.
In his first comments after being named as Trump's choice for Treasury secretary, Steven Mnuchin indicated in a Fox Business interview that the new administration's plans could quickly alter the collegial and consensus-driven dynamic Yellen has tried to mold.
The plan is to move soon to fill two open board seats at the Fed, and appointing one of those as a vice chair of supervision "will be a big priority," said Mnuchin, a former Goldman Sachs (NYSE:GS) partner and Hollywood financier.
Many analysts feel such a move could prompt the resignation of Fed Governor Daniel Tarullo ahead of the expiry of his term in 2022, giving Trump a fifth board seat to fill. A former Clinton administration economic advisor appointed to the Fed by President Barack Obama, Tarullo currently handles regulatory issues but has never been formally named vice chair. He would not comment on his plans in a public appearance last month.
UNNERVING UNCERTAINTY
Financial markets, which had been spooked by Trump's anti-trade comments during the campaign, so far appear to expect smooth sailing and a sober version of Trumpism.
The prospect of major tax reform has bolstered U.S. stocks, especially in the financial sector where regulations are expected to be eased, and the dollar has rallied against major currencies.
Yet for the Fed, Trump's victory brings a new and possibly unnerving sort of uncertainty.
The Fed has the equivalent of a university full of PhD economists who can employ sophisticated models to gauge how new tax or fiscal policies might change growth, inflation and unemployment.
What they can't model is the fallout if a major trade agreement is summarily ripped up, or if Trump follows through on campaign threats to declare China a currency manipulator.
"Do you think the ideologue or the pragmatist prevails?" said Cornerstone Macro analyst Roberto Perli, who like many in the markets argues that Trump's most volatile rhetoric won't find its way into practice.
Fed officials have so far struck a cautious note.
"It is time to be patient and see how things unfold," Governor Jerome Powell said at the Brookings Institution in Washington on Wednesday.
But some feel that policymakers may need to get on top of the coming wave.
"Fed officials can't simply dismiss the prospect of legislative reforms anymore," Dartmouth University economics professor and former Fed adviser Andrew Levin said. "It seems practically inevitable."