– Change At Top Of The Fed Also Brings Continuity
– Neither Hawk Nor Dove, Powell Won’t Pursue Big Policy Shift
– Fiscal Policy Could Alter Fed Assumptions, Rate Path
Written exclusively for InTouch Capital Markets
2nd October 2017
By Steven K. Beckner
Rarely does one associate change with continuity, but in the case of President Donald Trump’s nomination of Jerome Powell to succeed Janet Yellen as chairman of the Federal Reserve that is exactly what the U.S. central bank is getting.
He could surprise us, of course, but there is little in Powell’s background to suggest he will take the Fed in some new direction.
More change is on the way, though. With the presumed departure of Yellen, Trump will be able to fill all but one spot on the Fed Board of Governors with people of his own choosing.
Yellen’s term as a member of the Board extends well beyond her term as chairman — to Jan. 31, 2024. But it is doubtful she would want to stay on. In fact she has said many times she wishes only to “serve out her term” as Chairman, which expires Feb. 3. That leaves only Governor Lael Brainard, whose term expires in 2026, as a holdover from the Obama administration.
What these impending changes in the composition of the Fed Board and the Fed’s policymaking Federal Open Market Committee mean for the complexion of monetary policy will depend on Powell’s as yet unproven leadership skills. But it’s risky to presume that policy will change dramatically.
Powell himself was originally appointed by President Obama in 2012, but he’s a Republican who served as Under Secretary of the Treasury for Domestic Finance during the George H. W. Bush administration in the early 1990s.
It was there that I first met Powell while he was supervising the investigation and eventual punishment of primary dealer Salomon Brothers, accused of submitting false bids in Treasury security auctions.
I got to know him much better after he became a Fed Governor in May 2012. In the interim, he burnished his credentials and experience with financial markets as an investment banker — first as partner at The Carlyle Group and later as a managing partner of the Global Environment Fund.
“Jay” Powell, as he is better known, is an affable, good-humored man of 64, father of three, who was educated at Princetown University before earning a law degree at Georgetown University.
A man of considerable wealth, he will succeed an unbroken line of professional economists to the Fed captaincy. Not since G. William Miller has the Fed been led by a non-PhD economist.
However, the occasionally wry Powell is quite intelligent and able and has been schooled in the art of monetary policy for over 5 years as a Fed governor. In addition to this on-the-job training in monetary economics he has highly applicable knowledge of financial markets and institutions.
Perhaps it is time for a non-academic economist to run the Fed, although no doubt many would dispute that.
Neither Hawk Nor Dove – Open-minded
In the popular sport of applying aviary nomenclature to Fed officials, it’s not easy to affix a label to Powell when it comes to monetary policy. Though he was more eager than some to get on with normalization, he could hardly be called a “hawk.” But he’s no “dove” either. He’s a different kind of bird.
Powell, whose nomination seems likely to easily win confirmation in the U.S. Senate, has more clearly delineated his stance on financial regulatory issues. He’s argued for streamlining and making more transparent bank stress tests and advocates lightening the regulatory burdens of smaller banks.
He’s very well versed in the plumbing of the financial system and vital payments issues, having chaired a Financial Stability Board subcommittee, charged with reforming the London Interbank Offering Rate (LIBOR).
As a monetary policymaker, Powell has seldom diverged from the FOMC consensus. So it’s not clear what new direction, if any, Powell might take the Fed.
Powell has not had a great deal to say publicly about monetary policy, but generally speaking he has been fully on board with Yellen’s slow, cautious, “gradual” approach to normalization.
Perhaps not surprisingly, given his market background, Powell was more worried than others about the risks to financial instability posed by leaving rates too low too long.
But on the whole he has gone down the line with Yellen and the FOMC majority. Not only has he never dissented against an FOMC decision he has let it be known from time to time that he supports the Yellen approach.
Powell Has Wanted To Proceed Cautiously, Patiently
In June comments, Powell told the Economic Club of New York, “The healthy state of our economy and favorable outlook suggest that the FOMC should continue the process of normalizing monetary policy. The Committee has been patient in raising rates, and that patience has paid dividends.”
Going back to early 2015, Powell saw the risks of lifting off from the zero lower bound too early as outweighing the risks of doing so too late. He was prepared to do more later if necessary rather than incur a recession by starting the normalization process too soon.
In May of last year, five months after the FOMC began raising the funds rate following seven years near zero, Powell was in no hurry to move again, saying, “the risks of waiting are frankly not so great. This doesn’t feel like an economy that’s bubbling over or threatening to break into high inflation.”
Later in 2016, Powell was content to let the September meeting go by, even though many Fed watchers had been expecting a rate hike then, believing that global uncertainties and low inflation justified waiting a bit longer and giving the economy more room to run and reduce unemployment.
By the time of the December 2016 meeting, Powell was ready to go, but still believed the FOMC needed to proceed gradually.
Aside from the fact that inflation was running well below the Fed’s 2% target, Powell had increasingly come to accept the theory — propounded by San Francisco Federal Reserve Bank President John Williams and Thomas Laubach, chief of the Board’s Division of Monetary Affairs — that the real equilibrium short-term interest rate (r*) and in turn the longer run federal funds rate had fallen considerably.
In line with that thinking, FOMC participants have reduced their estimate of the longer run “neutral” funds rate from 4.25% in early 2012 to 2.8% as of the September Summary of Economic Projections. That in turn has flattened the path of the actual funds rate.
When it came to deciding the timing of funds rate hikes versus balance sheet shrinkage, Powell was squarely in the camp that prevailed, delaying reduction of the Fed’s $4.2 trillion bond portfolio until last month. Early on, he was in full agreement with Yellen and the FOMC majority about beginning monetary normalization by increasing the federal funds rate, not by shrinking the Fed balance sheet.
While some Fed officials argued for shrinking the balance sheet before raising the funds rate, Powell joined the majority in maintaining that the FOMC should first distance itself from the zero lower bound on the short end of the yield curve while keeping downward pressure on the long end by continuing to reinvest and rollover maturing securities until funds rate normalization was “well underway.”
Powell took the position that the funds rate should be the Fed’s “primary tool” and that the FOMC should get away from zero as much as possible to give itself room to cut rates if necessary.
If the Fed had begun shrinking the balance sheet earlier, Powell believed, it would have meant raising the funds rate less and leaving the Fed perilously close to the zero lower bound and giving the Fed less room for countercyclical monetary policy.
Although Powell has supported such concepts as the falling r*, Powell is not doctrinaire — unless the doctrine is pragmatism. He has a healthy skepticism of constructs like Okuns’s Law and the Phillips Curve.
As a non-economist Powell will likely be carrying less ideological baggage — specifically the Keynesian belief, still prevalent around the Federal Reserve system, in a Phillips Curve trade-off between unemployment and inflation. He is prone to greater open mindedness about why inflation is so stubbornly low, but not so hidebound as to think below-target inflation paralyzes monetary policy.
Neither a “hawk” nor a “dove,” he’s inclined to make policy based on the facts before him. Do the incoming data validate the Fed’s forecasts? That is the basic question he’s inclined to ask.
Unlike Stanford University Professor John Taylor, who likely would have brought a more rule-based approach had he been named chairman, Powell is more inclined to take a discretionary approach, although certainly he’ll be comfortable using things like the Taylor Rule as useful guidelines or reference points.
Unlike Taylor, Powell is a lawyer by training. But that need not be a disabling weakness. Having been steeped in monetary economics for five years he has a good understanding of how things work. Certainly he knows how financial markets work, which counts for a lot. After all monetary policy is transmitted via financial conditions.
And of course there is no shortage of PhD economists at the Fed to advise Powell. He is sure to get an earful from the Fed staff, but he is likely to take their input under advisement and weigh anecdotal information on the economy and financial markets.
Fiscal Policy May Pose New Challenges For New Fed Chief
Powell is coming to the Fed leadership at a challenging, not to say complex, time. For one thing, the U.S. is on the cusp of some major changes in fiscal policy that could complicate monetary policy.
Trump’s nomination of the new Fed chairman coincides with announcement of a major tax reform package, which if enacted could have significant bearing in the economic outlook and on the Fed’s policy assumptions.
Just at a time when Fed policymakers have accepted the notion that weak productivity, slower labor force growth and other factors have lowered the real equilibrium rate and in turn the neutral funds rate, Congress seems on the verge of enacting tax cuts that could speed productivity growth, accelerate GDP, boost demand for capital and put upward pressure on rates.
Having just accepted a “new normal” for real (and nominal) rates, Powell and his colleagues may soon have to face a new reality — the prospect of a steeper rate path than has heretofore been contemplated.
Powell might prove to be more willing to reassess, if not dump the prevailing assumptions in the face of growth inducing tax cuts, not to mention extensive deregulation.
The logic of such a change of heart could mean a higher neutral rate and thus more aggressive funds rate hikes than those found in the latest FOMC “dot plot” (a third quarter point rate hike this year; three more next year and another three over the following two years, leaving the funds rate at 2.9% in 2020).
Powell’s Independence, Leadership Could Be Tested
That might not sit to well with Trump and other Republicans.
And so we could get a fairly early test of Powell’s political independence. In an earlier era Taylor and other Republican advisors chafed when an Alan Greenspan-led Fed mounted an aggressively preemptive assault on inflation that saw the funds rate rise from 6 1/2% in March 1988 to nearly 10% in February 1989.
That kind of spike in rates is very unlikely now. But any persistent tightening could be seen as putting the expansion in jeopardy and result in political pressure on Powell & Co. to ease up.
If the economy does go into a downturn we could also get another test of how nimbly Powell et al would be willing to use counter cyclical monetary policy including unconventional policies, such as renewed quantitative easing.
So, what of Powell’s leadership qualities? He’s something of an unknown quantity in that department. Other than heading the FSB committee, he has not had a chance to demonstrate his leadership skills.
I don’t foresee him being a commanding type of Fed chairman in the style of a Paul Volcker or even Alan Greenspan. I suspect Powell will continue the atmosphere of collegiality that has prevailed most of the time going back to the Bernanke Fed.
Returning to the theme of continuity, let’s remember that the Fed does have a statutory dual mandate and that there is a good deal of institutional inertia that is likely to propel monetary policy forward in a not unfamiliar way.
If there is to be a dramatic change in the course of monetary policy it will likely be dictated by changed circumstances, not by any ideological lurch.
There will be a steady new hand at the tiller.
Steven Beckner is a veteran financial journalist with four decades of experience of reporting on the Federal Reserve. Mr Beckner is the author of Back From The Brink: The Greenspan Years (Wiley, 1997) and can also be heard speaking regularly on National Public Radio.