Trump is set to have an unusual level of influence over the Fed -- and that's needed right now

Trump Yellen wideCarlos Barria/Reuters; Composite by Bob Bryan/Business InsiderPresident Donald Trump and Fed Chair Janet Yellen

With four key vacancies on the Federal Reserve’s Board of Governors, President Donald Trump is set to reshape the central bank.

A fifth spot could open by February, when Chair Janet Yellen’s four-year term ends. Trump said Thursday that he likes and respects Yellen, but hasn’t made a decision on whether to renominate her yet.

Trump, who values loyalty, might well appoint yes-men and women to lead the central bank. “Investors I talk to in the US, Europe, and Asia are in my view too complacent about the risk that we going forward will get a politicized Federal Reserve,” according to Torsten Slok, Deutsche Bank’s chief international economist, in a recent note.

That’s the extreme scenario that could increase the market’s uncertainty about how much inflation the Fed would tolerate.

But a tighter relationship between the White House and the central bank is desirable right now, according to Paul Sheard, the chief economist at S&P Global. The post-crisis economy has been marked by low inflation, which is the opposite of what central banks have been trying to achieve by keeping interest rates low to encourage spending. To address this, Sheard said, we need to have a different mindset about the Fed’s independence.

“You can still have independence, but coordination and closer communication is probably not a bad idea,” he told Business Insider. It’s “quite beneficial in the sort of circumstances that the world has been in since the financial crisis.”

The idea of independent central banks, Sheard said, dates back to the 20th century, when the threat was not deflation, but hyperinflation.

The lesson learned? “If you don’t make the central bank independent, then the government would have the tendency to spend too much, run up its budget deficit, and rely on the central bank to fight those deficits, and that would end up being inflationary,” Sheard said.

But now that central banks are fighting deflation, it might be more desirable to have governments run bigger deficits to stimulate growth, with central banks on board to assist. “It’s a way of getting economies back to full employment and getting inflation back to target much quicker than has been the case,” Sheard said.

And so, it’s really a question of whether the relationship between the Fed and the White House can be updated for present-day needs. That’s different from a situation where the central bank is seen more as a lackey of the government, Sheard said.

Whether that relationship helps the economy is a big question mark. As Sheard noted, Trump is new to politics, and hasn’t necessarily bought into the Fed’s super-academic approach, as another president might have.

“What the market would probably react rather badly to was a sense that the Fed was being politicized and people who really didn’t have the necessary expertise were being appointed,” Sheard said. “In other words, if it was not just the independence, but the integrity of the institution” that was in jeopardy.

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