The article was originally published in November 2017.

The Federal Reserve has just announced a change in leadership: Obama-appointed Janet Yellen will depart in February 2018, and will be replaced by Trump's pick, Jerome Powell.

One question for Powell moving forward will be how to navigate a slightly riskier business phase. Beginning in October, the Fed began tightening the U.S. economy, a process that must be carried out carefully so as to not to spark a recession, as it can leave the economy more vulnerable to negative shocks. Particularly with the upcoming appointment of Powell, it is extremely important that the Fed does not tighten the economy too quickly, so that it can switch to easing if the need arises.

This year, the economy grew 3.1% and 3% in the 2nd and 3rd quarters, respectively. This is the best reported back-to-back performance that the United States has seen since 2014. In fact, this pace of growth exceeded the bank's estimate of 1.8% growth. However, the Fed believes that this 3% growth cannot be sustained for long, as the economy is currently operating at around/beyond full employment, which could possibly lead to inflationary pressures. In order to offset such pressures, the Fed hopes to tighten the policy by 100 basis points for the next two months until the end of the year. Basis points (BPS) are a unit of measure for interest rates and 1 basis point is equal to 1/100th of 1% (or .01%). Tightening by 100 basis points is equivalent to increasing interest rates by 1%. The 100 base points is still only a projection and is not set in stone.

There are also plans to slow employment growth by 100,000 jobs per month. This puts the U.S. economy in a vulnerable position, and Powell may have quite a difficult task of gauging the pace of the slowdown. A slow economy does not automatically signal a recession, but care should be taken that these policies to not eventually lead to a recession.

There are several challenges that the Fed must look out for. These include the existing inflationary pressures, productivity growth, and tax cuts. All of these scenarios threaten the current agenda. It is possible that productivity growth may accelerate, pushing the neutral rate of interest, or the rate at which real GDP is currently growing, even higher. Additionally, if Congress agrees on a substantial tax cut in hopes of supporting consumer spending, this might require the implementation of a more aggressive rate hike.

According Janet Yellen, the Fed's tool for a tightening monetary policy would be to raise short-term market interest rates by paying banks greater interest on reserves (IOR). Janet Yellen also acknowledged that reducing the balance sheet is largely a substitute for raising the Fed's policy rate. Thus, the Fed is planning to reduce the balance sheet by $450 billion through the end of 2018, roughly equivalent to a 1% hike in the policy rate.

With the Fed continuing to tighten the economy, foreign central banks will likely remain the main driver of the U.S., and as central banks removed stimulus, the U.S. dollar is expected to depreciate over the longer term. The Fed must be careful in factoring key indicators to properly determine the rate at which it plans to tighten the economy. If this is done, potential negative outcomes can be avoided.