May 12, 2021
Jerome Powell’s term as chair of the Federal Reserve Board does not end until next January, but the debate on his reappointment has already begun. It would be good for the economy if Powell were reappointed and if Biden announced this decision as soon as possible.
In making the case for Powell, it is important to understand how much he has moved the Fed from where it has been in prior decades. I have long been in battles with the Fed over its willingness to raise interest rates, slowing growth and killing jobs, in order to head off the risk of higher inflation. It viewed its legal mandate for high employment as an afterthought, at best.
Powell has turned this around. He has quite explicitly said that he wants to have the economy run hot, pushing it as far he can without kicking off inflation. He has embraced the idea that many of us on the left had long maintained: low levels of unemployment disproportionately benefit those most disadvantaged in the labor market.
When the unemployment rate is low, Blacks, Latinos, people with disabilities, and people with criminal records are more able to find jobs. Employers don’t have the option to discriminate; these are the workers who are available.
Low rates of unemployment also give workers at the middle and bottom of the income distribution the bargaining power to obtain wage gains. We have seen this pattern repeatedly in the last four decades.
When the unemployment rate has been relatively high, for example in most of the 1980s, the early 1990s, the Great Recession, and the slow recovery that followed, real wages for most workers were stagnant. However, when the labor market tightened, in the late 1990s or in the four years before the pandemic, workers were able to secure wage gains in line with productivity growth. (This was the main focus of two books I wrote with Jared Bernstein.)
While this view may seem like common sense – why not run the economy in a way that as many people as possible can have jobs – it is a world away from where the Fed has been in the not distant past, where the view was that the Fed had to focus on inflation. I recall being in a meeting in early 1994 with Alan Blinder and Janet Yellen (yes, that Janet Yellen), who were both recently appointed members of the Fed’s Board of Governors.
The immediate issue was that the unemployment rate was falling to the 6.0 percent level that was generally viewed as the point where inflation would begin to spiral upward. My colleagues and I were trying to convince Blinder and Yellen to hold off on raising rates and slowing the economy since we thought the risks of inflation were small relative to the benefit from millions of people being able to get jobs.
We weren’t able to move them. I will always recall arguing with Blinder that since we didn’t know for sure the impact of lower unemployment on inflation, it was worth taking the risk. Blinder responded that the Fed was legally mandated to pursue price stability. I pointed out that the Humphrey-Hawkins legislation, which was then still in effect, required the Fed to target 4.0 percent unemployment.
Blinder, who was one of most liberal and decent people to ever sit on Fed’s board, responded by saying that no one takes that mandate seriously. I then said that he doesn’t have to take the mandate for price stability seriously either, to which he said “yes, I do.”
Later that year, Blinder actually got caught up in a mini-scandal for suggesting that the Fed could act to boost employment when the economy was facing a recession. A major New York Times article implied that this was a major break with Fed policy since Blinder’s comments indicated that the Fed would not just be focused on inflation.
Anyhow, having a chair who sees the Fed’s priority as running the labor market as hot as possible without triggering inflation is a very different world. The change in views reflects a lot of work over the decades trying to impress on the Fed the importance of getting to full employment. Most notably, the Fed Up Coalition, consisting of labor and community groups, of which Ady Barkan was a lead organizer, played a major role in swaying the Fed. Janet Yellen, who was then chair of the Fed, met with the group several times, as did other board members and district bank presidents. They seemed to take our arguments seriously.
Yellen, and even her predecessor Ben Bernanke, had certainly moved the Fed from its inflation obsession, but Powell still took a qualitative leap forward. In saying that it is the Fed’s responsibility to have a tight labor market and get the unemployment rate as low as possible, he has totally reversed the Fed’s priorities. Having won a huge battle on economic policy, progressives should be anxious to defend our victory.
Powell and Regulation
Many people have pointed out that Powell has not been good in regulating the financial sector, which is another important responsibility of the Fed. This criticism is valid, but it really needs to be put in some context.
First, there is a seriously wrong myth about the Great Recession, which sees it as the result of failed regulation, that needs to be corrected. There were indeed many failures in regulation in the years before the Great Recession, but the problem was the collapse of a housing bubble that was driving the economy.
The distinction is important because the regulation story implies that we needed super-sleuths to uncover the fraudulent loans in the sub-prime market or the flood of credit default swaps being issued on mortgage backed securities by AIG and others. These abuses surely fed the bubble, but the bubble was sitting there in plain sight for anyone paying attention, and most importantly, it was easy to see that it was driving the economy.
We had an unprecedented run-up in house sale prices with no remotely corresponding increase in rents. And, this was occurring while vacancy rates were hitting record levels, which is hard to reconcile with claims that prices were being driven by the fundamentals of the market.
It was also easy to see that the bubble was driving the economy, as residential construction was hitting record shares of GDP. In addition, the wealth created by the bubble also led to a consumption boom, as homeowners were spending based on the ephemeral housing wealth created by the bubble. This could easily be seen in the GDP data published by the Commerce Department every quarter.
When the bubble burst, it was inevitable that we would face a serious recession, as there was no obvious source of demand that was going to replace the construction and consumption demand generated by the bubble.
To prevent the disaster of the Great Recession, we didn’t need the Fed to get into weeds of regulation. We needed a Fed that recognized the risk of a bubble that was driving the economy instead of cheering it on, as Greenspan largely did until he stepped down in 2006.
Bubbles are not dependent on bad finance. The stock bubble in the late 1990s, whose collapse gave us the recession in 2001, did not depend to any substantial extent on credit. People put up their own money to buy ridiculously priced shares of stock.
The collapse of bubbles also doesn’t necessarily lead to a recession. This is only the case if the bubble was actually driving the economy, as was the case with the stock bubble in the 1990s and the housing bubble in the 2000s. If the $1 trillion market for Bitcoin collapsed completely tomorrow, we probably would not even be able to find its impact in the GDP data. (I discuss this issue in more detail here.)
Anyhow, even if bad regulation weren’t responsible for the Great Recession, we still should want a well-regulated financial system. There are three important reasons why regulation matters.
First, much of finance, for example subprime house and car loans or fees for financial services, is predatory. Contracts and loans are often designed deceptively so customers don’t realize the full costs and risks. Banks and other financial companies usually target low and moderate income people and people of color with these products.
Second, the financial sector is a major source of inequality. Many of the country’s biggest fortunes were made in the financial sector. We can debate how much money a person should get when they are responsible for a genuinely useful innovation, like an important drug or new software, but it’s hard to see a way to justify someone getting very rich off subprime mortgages.
The third reason regulation is important is that a bloated financial sector is inefficient. The financial sector provides an important service; it allocates capital and facilitates payments. But we should want this to be done with as few resources as possible. We should think of finance like we think of the trucking industry – we need to get goods from point A to point B – but we want as few people and trucks employed in this process as possible.
The same applies to the financial sector. The sector has quintupled relative to the size of the economy over the last five decades, with little obvious benefit. If we can limit the bloat with regulation, that makes the sector and the economy more efficient.
For these reasons, we should want a well-regulated financial sector and there are certainly grounds for criticism of Powell on this front. However, the more obvious target here would be finding a good vice-chair for regulation. The term of the current vice-chair, Randal Quarles, ends in October. It will be important to replace him with someone who takes regulation more seriously.
Other Issues: Climate and Cities
Some have complained that Powell has not made climate a factor in Fed policy. There also have been complaints that the municipal lending facility he created in the recession was barely used.
These complaints are not really fair to Powell or the Fed. It would be great to have a central bank that actively promoted clean energy and sought to penalize fossil fuel companies, but this is not a power that has been given to the Fed by Congress. While it can arguably do this with the power it has, it would be virtually certain to lose this power very quickly if it went this route.
We can be quite certain that every Republican in Congress would be up in arms if the Fed were to pursue this path, as would likely be the case with many Democrats. If this had happened with Donald Trump in the White House, we would also have the executive branch out for Powell’s head. It is hard to see the value in pursuing a policy that is virtually certain to be cut off before it can have any real impact and likely to lead to a Fed with much less autonomy.
The same applies with lending to cities. In fact, the Fed’s policies led to a sharp reduction in the interest rates on municipal bonds between February and April of last year. The ability to borrow at lower interest rates helped many cities get through the pandemic. However, there were cities with bad credit ratings that benefitted less from the drop in interest rates.
It would have been great if Powell could have tossed these cities a lifeline by lending at well below market rates, but here too we have to look to the reaction from Congress. The Republicans in Congress, along with Donald Trump, were quite explicit in their efforts to keep “Democrat” cities from getting money. Had Powell tried to use the Fed as a backdoor, they would not have sat by and twiddled their thumbs helplessly. Again, they would have gone gunning for Powell and the Fed, and they would have likely succeeded in reining in the lending and weakening the Fed.
In both of these cases, we can argue whether the Fed had the legal authority to do more, but as a practical matter, it almost certainly would have been blocked in these efforts. The Fed’s main responsibility is the state of the macroeconomy, and I find it hard to argue that Powell should have put the Fed’s ability to be effective here at risk to pursue initiatives that were virtually certain to be shut down quickly.
Why Powell and Why Now
While Powell had brought about a remarkable shift in Fed policy, it could be argued that others, most notably Fed Governor Lael Brainard, could carry this shift forward as well or better. There are several reasons why ditching Powell would be a risky strategy.
Most importantly, Powell would have the best chance of getting confirmed by the Senate. The Republicans have made it fairly explicit that their agenda for the Biden presidency is sabotage. If Biden wants to appoint a Fed chair committed to full employment, they will look to block them. We can assume that all 50 Republican senators will vote no, on almost anyone that Biden puts forward. That means that if any of the centrist Democrats decide to get cute, Biden doesn’t have a Fed chair.
Powell has a huge advantage in this area in that he already secured the vote of almost every Republican in the Senate when Trump nominated him in 2017. (There were only four no votes from Republicans.) There are few limits to Republican shamelessness. Many may decide that if Biden wants Powell, then they don’t, but clearly the person Trump picked to be Fed chair has a better chance of winning their support than anyone else Biden might put forward.
There is also the question of the Fed chair’s authority at the Fed. Decisions on monetary policy are not made by the chair alone but rather by the Fed Open Market Committee (FOMC), which includes the other six governors and the twelve district bank presidents, five of whom vote at any given meeting. The chair usually gets their way, but they typically negotiate and work out compromises with the other members of the FOMC.
Powell, as the incumbent chair, would have much more authority in this situation than a new person just stepping into the position. There are still many inflation hawks among the district bank presidents. Powell will be much better situated to keep the priority on full employment than any possible replacement.
In terms of announcing his reappointment soon, Biden should want to do what he can to remove uncertainty and shore up Powell’s position in coming months. We know that the Republicans will do everything in their power to stir up fears of runaway inflation and to undermine the Fed’s authority. If Biden can give him a clear endorsement now, it would help Powell’s effort to keep the focus on full employment.
We know that there will be areas with jumps in prices due to a bounce back from pandemic drops or temporary shortages, as we saw in the April CPI report. We need the Fed to be able to look at the data clearly and respond accordingly. Powell will be most able to do this if there is no doubt about his reappointment.
This should be an easy one for Biden. He will be reappointing a chair with a proven track record. And, he can show his willingness to be bipartisan by handing over one of the most powerful positions in government to a Republican.