Jerome Powell and the Federal Reserve Board

Jerome Powell answers a reporter's question at a June 16 2019 press conference.

October 15, 2021

I didn’t expect to write again about Powell being reappointed as Fed chair. I had expected that Biden would have made a pick by now, but here we are. Now that Larry Summers has condemned the “woke” Fed for failing to crack down on inflation, it seems worth recapping what is at issue.

What we are seeing right now is a Federal Reserve Board that is doing the right thing in the face of the hysteria of its critics. The critics want to see it move rapidly to slow the economy so that they can again get good help cheap. Specifically, they would like to see the Fed end its quantitative easing program (buying bonds and other assets) and raise the short-term interest rate it controls, in order to reduce demand in the economy.

Higher interest rates will slow the economy by making it more expensive for people to buy homes and cars since they now have to pay a higher interest rate on their mortgages and car loans. Higher interest rates will also end a boom in mortgage refinancing that has saved homeowners tens of billions of dollars in interest payments. The arithmetic on this is straightforward. If someone had a $250,000 mortgage at a 4.25 percent interest rate, and was able to refinance at 3.25 percent, they saved $2,500 on their annual interest payments by refinancing.

That’s a big deal for a middle-income family earning $80,000 a year. Some of the money saved on interest payments will go into other spending, providing another channel for boosting the economy.

Higher rates will also raise the interest burden that state and local governments would face if they want to borrow to finance items like improving infrastructure, extending broadband access, or renovating and repairing schools. And, higher interest rates can make it more difficult for companies to raise money for investment, providing another channel to slow growth and job creation.

In prior decades, the Federal Reserve Board was very quick to raise interest rates over concerns about inflation. In fact, under Greenspan, Bernanke, and Yellen, they often raised interest rates preemptively, slowing the economy and job growth even before inflation had actually begun to rise. These rate hikes were justified by appealing to the Fed’s mandate to target price stability.

However, that is only half of the Fed’s mandate in its conduct of monetary policy. It is also mandated to promote high employment. Powell has made a sharp break with his predecessors in placing an equal priority on high employment, recognizing the enormous gains to the country from maintaining low rates of unemployment.

As Powell has noted, the big winners from low rates of unemployment are those at the bottom end of the labor market – the people who face the most discrimination. When the unemployment rate gets low, as it did before the pandemic, the workers who are getting jobs are disproportionately Blacks, Hispanics, people with less education, the disabled, and people with criminal records. These are workers that employers often avoid hiring when the unemployment rate is high, but in a tight labor market they have to look to hire workers they would not otherwise consider employing.

Tight labor markets also make it possible for tens of millions of workers at the middle and bottom to achieve real wage gains. For most of the last four decades, real wages for workers at the middle and bottom stagnated, as most of the gains from productivity growth went to those at the top end of the income distribution. But when labor markets got tight, in the 1990s boom and in the years just before the pandemic recession, workers at the middle and bottom saw rising real wages.

This is also the case today, as workers in many low-paying sectors, like hotels and restaurants, are seeing substantial wage gains as employers must compete for their labor. This is the problem that Larry Summers and many others want the Fed to address. They want it to jack up interest rates, to slow the economy, and take away the bargaining power these workers now have.

Thankfully, Powell is still standing tight in his commitment to high employment. This is even as supply chain disruptions are creating shortages of some items and leading to higher inflation in many areas.

Powell is pursuing the policy that many progressives have demanded from the Fed for decades. Some of us thought that this would give him a lock on being reappointed by a president who ostensibly is committed to increasing workers’ pay and bargaining power. Incredibly, many progressives are now pushing hard to deny Powell a second term as Fed chair.

The Case Against Powell

The issues mostly raised are Powell’s stance on financial regulation and global warming. On the former front, people have pointed to several actions where Powell has supported measures to weaken bank regulation. To my view, these have been mistakes, but Powell has always deferred to the Fed governor responsible for overseeing the Fed’s regulatory powers.

Until 2017, that was Daniel Tarullo, a pro-regulation Democrat appointed by President Obama. In the last four years, the governor overseeing the Fed’s regulatory actions had been Randal Quarles, an anti-regulation Republican appointed by Trump. Quarles’ term ended Wednesday, which seems to beg the question, why hasn’t Biden nominated a pro-regulation replacement. FWIW, Powell has testified to his intention to continue to defer to the governor responsible for regulatory oversight in his future votes.

It is also worth pointing out that the Fed’s actions on regulation are far less consequential than its actions on monetary policy. While it is important to minimize waste and abuses in the financial sector, we have other regulatory bodies. Also, the consequences of a poorly regulated financial system are not nearly as dire as the consequences of a Fed that needlessly throws millions of people out of work to stem inflationary fears.

Some progressives have exaggerated the importance of regulation because they misunderstand the cause of the Great Recession. The story there is a simple one, we had a massive housing bubble that was driving the economy. Its collapse was certain to lead to a sharp downturn. This recognition did not require great regulatory scrutiny, it required that people look at the GDP reports that the Commerce Department publishes every three months.

As someone who warned about the crash long before it happened, I appreciate being lectured on the importance of regulation by people who were caught by surprise. But, I am used to the way things work in Washington.

The other big item in the case against Powell is his actions, or lack thereof, on climate change.[1] It would be great to have a central bank that was acting aggressively to try to reduce greenhouse gas emissions. While it may be possible to read this responsibility into the Fed’s mandate, it is very clear that Congress has not explicitly given the Fed this role.

The idea that the Fed could somehow have taken major steps to stop the flow of capital to fossil fuel companies, without a major reaction from Congress, is more than a bit far-fetched. It is even more far-fetched to think that a new nominee for Fed chair, with an explicit commitment to using the Fed’s power to try to rein in greenhouse gas emissions, would be approved by a 50-50 Senate.

We absolutely need to act quickly to slow global warming, but assigning imaginary powers to government agencies will not do the trick. The Fed can use its research capabilities in a productive way to call attention to the costs that many in the economy will be forced to bear if global warming is not checked, but it is not going to provide a backdoor to get around a Congress that is not prepared to act.

Reappoint Powell Now

In short, to my view the case for reappointing Powell is overwhelming. I wish that Biden would put the guessing game to an end now and reinforce Powell in his effort to hold the line against the inflation hawks. But, of course, I argued for reappointing Powell “now” several months back as well. Biden should also appoint a solid regulator to fill Quarles’ position, such as current governor Lael Brainard or former governor, and Deputy Treasury Secretary, Sarah Bloom Raskin.

President Biden will face many tough calls in his presidency. Reappointing Powell should not be one of them.

[1] I know some folks have dug up other responsibilities of the Fed as well. As far as I know, Powell has not done a good job of keeping the sidewalks on Constitution Avenue clean after a snowstorm. I would not recommend Biden consider that in his decision to reappoint Powell.


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