In naming attorney and investment banker Jerome Powell to succeed economist Janet Yellen as chair of the Federal Reserve Board of Governors, President Donald Trump steered a moderate and prudent course. This was not foreordained.
This happened on the day when a right-wing radio personality with no scientific background withdrew from being nominated as USDA’s chief scientist. And one of two federal judge appointees deemed unqualified by the American Bar Association, out of a cohort of 42, faced harsh questions in the Senate. In contrast, Powell’s nominsation offends or frightens almost no one. That is good, but leaves open the question of how he will perform as chairman.
Consider this from three facets.
First, how will he act in nonemergency, day-to-day monetary policy? Over the medium term, virtually any Fed chairman would oversee the gradual shrinking of the “monetary base” of the money supply, and thus increase interest rates. This includes Powell. But circumstances remain extraordinary.
Interest rates during the six years following the financial debacle of 2007-2009 were so extreme that a return to more historic rate ranges is inevitable. The debate is over the rate of change. Yellen favored a middle position. Two successive Minneapolis Fed presidents and some liberal economists opine that such tightening is premature. Conservatives, including Stanford economist John Taylor and former Fed governor Kevin Warsh, both short-listed for the Trump nomination, have advocated higher rates for years now. And, in his 2016 campaign, Trump slammed Yellen for bad policy — the only time this has happened in U.S. history. So a year ago, the president also apparently favored sharply higher rates.
Expect Powell to steer a middle course, one that will arouse minimal dissent from the other 11 voting members of the policy-setting Federal Open Market Committee or cause bobbles in bond or foreign exchange markets. If the economy grows moderately, the committee will let the monetary base erode slowly and the rate creep up. If current tight labor markets cause notable wage and price growth, which is not likely, expect a faster pace of tightening. And if growth slows, even to a near-halt, expect the rate creep-up to stop, but not any dramatic return to the zero interest rates of the Ben Bernanke era.
The second issue to consider is regulation of financial institutions broadly and those under statutory supervision by the Fed specifically. Powell again is a moderate. He has argued that the post-crisis Dodd-Frank act increased regulation too much and imposed excessive burdens, especially on smaller banks. But he advocates changes, not total repeal. This is in marked contrast to Randal Quarles, a recently-confirmed new appointee to the Fed Board who takes on a special function as the Fed’s regulation czar. Three more seats remain empty, with yet another opening if Yellen resigns her board seat, which is distinct from the chairmanship and which runs for another six years. Who Trump names to these remaining seats will have more effect on regulatory changes than who wields the gavel at board meetings.
Note that if Yellen steps down from the board, as expected, and Trump gets four more of his appointees on it, he will have achieved an unprecedented 5/7 majority in the first year or so of his presidency. The Federal Reserve Act is structured so that naming even four out of seven should not occur until the seventh year of a two-term presidency. The system is broken, but that is the subject of another column.
The third issue is the most crucial: How will Powell perform if there is another financial sector crisis resembling that of 2007-2009, even if not as severe? Or what if there is an international crisis like Mexico’s hitting the wall in 1982, the European Monetary System crisis in the fall of 1992 or the Asian crisis in 1997? This is a question of temperament as much as education or experience.
History will give Bernanke a C- for his performance up to August, 2007, largely because of his blindness to the dangers that had arisen in our financial markets. But he will get a B+ or better for his response to the crisis as it unfolded, particularly as a lame-duck President George W. Bush went AWOL in terms of economic leadership. It had not been obvious that an academic with little policy experience would do this well. Would Jerome Powell meet this bar? This is impossible to say, but he is experienced in investment banking and at the U.S. Treasury, knows finance well, even if not an economist, and is said to have good judgment.
Let’s hope for the best. We are back to an unsustainable bubble in equity markets. We have a highly unproven treasury secretary whose performance this far raises doubts. Domestic and international politics are such that there are myriad plausible scenarios for external shocks that could cut economic confidence off at the knees. These range from Brexit dissolving into a debacle for Britain and possibly Europe to a possible open conflict on the Korean Peninsula to a politically messy presidency here at home.
The confirmation process for Fed governors has become far too politicized. Democrats would be well-advised to keep their powder dry and vote for Powell along with Republicans, if only to show bipartisanship might be reestablished. If Trump fills the remaining open seats with less centrist or less qualified people, there will be ample opportunity for political street theater.