The Toughest Job in Washington: The Next Fed Chair

The next person at the helm of the central bank will inherit a plate full of policy challenges.

Federal Reserve Board Chairman Ben Bernanke
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You might say that Ben Bernanke has one of the toughest jobs in America—leading the central bank amid a prolonged economic downturn. But save some pity for someone even less lucky: whomever takes his job next.

Ben Bernanke's term as Federal Reserve Chairman is up in January 2014, and the next chair will face a host of challenges: the slow recovery and tight fiscal policy that Bernanke deals with, plus the potential need to unwind unprecedented policy moves.

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That timing could mean "a change of leadership at the Fed at a time when the Fed is probably the most active and only game in town in terms of policy, and fiscal policy is constrained," says John Canally, economist for LPL Financial.

It looks likely that a new chair would preside over a sustained, if slow, recovery. The Federal Reserve projects the jobless rate relaxing to a central range of 7 to 7.7 percent in 2014—a relief from the current 8.2 percent, but still uncomfortably high. As the economy recovers, a new chair will preside over shutting down current Fed policies that aim at stimulating the economy. That ranges from inching up near-zero interest rates to unwinding two (or more) rounds of quantitative easing, massive purchases of assets with a goal of boosting lending.

Both rounds of this unconventional policy have inspired unease, such as fears of inflation. Just as those outcomes were unknown, so are the repercussions of selling all of those assets back onto the market.

"We've never undone this. The first time we try to exit from these policies, we're going to be learning what that process is like," says Kim Schoenholtz, director of the Center for Global Economy and Business at NYU's Stern School of Business. "The Fed seems to be confident that it can do so, but having never done so, one should naturally be cautious about potentially unintended consequences."

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And there could soon be more to undo. The Federal Open Market Committee is meeting next week, and expectations for a third round of easing, or "QE3," are growing higher with every new Fed meeting. The committee's June minutes showed that some members think more stimulus will be needed, and the Fed also predicts inflation at or below its target in the medium-term—meaning that there seems to be room for that stimulus.

Add all that to EU turmoil, domestic fiscal policy deadlock, and persistently high unemployment, and it looks like a recipe for more Fed action.

There is even talk about further unconventional methods—a recent report from Bank of America Merrill Lynch lists "nuclear options" that the Fed might undertake if the economy should take a nosedive—worst-case-scenario options like buying up treasuries to put a ceiling on yields, or enacting policy "triggers" tied to indicators like unemployment or inflation.

All of which is to say that whatever policies the Fed undertakes now will mean more work for whoever is tasked with disengaging from those policies in the future.

"Each subsequent stimulus initiative the fed puts into play is just another fishing line that has to be reeled in later," says Greg McBride, senior financial analyst at Bankrate.com.

Bringing the Fed back into conventional policy territory is just one difficulty that a new Fed chair might face. Along with slow recovery, tight fiscal policy will be around for years to come, potentially increasing pressure on the Fed to buoy the economy.

And that's not the only pressure that could come from Capitol Hill, says Canally. He foresees the possibility of an end to the Fed's dual mandate, an idea championed by some Republican members of Congress.

"If you upset enough members of Congress and get enough people in the Senate to agree, [they] could say, you know what, Fed, we're just going to make you responsible for inflation. Full employment? That's not your job, that's our job."

There are, of course, plenty of "if"s involved in reading the Fed tea leaves. Recovery could be strong and accelerating by 2014, or it could remain in the doldrums—no deal or even a late deal on this year's so-called "fiscal cliff" could be a profound drag on future growth.