Would you appoint a sociologist to run a nuclear power station? Or an economist to the position of Lord Chief Justice? Clearly not, so, why has Donald Trump appointed a lawyer to run the Federal Reserve—the US and arguably the global—central bank, when Janet Yellen steps down next February? The choice matters because of America’s still commanding influence on global economic and financial affairs. Jerome, or Jay, Powell is not a bad choice for the Fed, but he is not who you’d want for the challenges that are almost certainly going to crop up in the next few years.
Who knows what drives President Trump’s choices? Yellen’s credentials and record made her a shoo-in for re-appointment. Perhaps Trump disapproved because she was an Obama appointee. Perhaps he and Treasury Secretary Steve Mnuchin wanted someone more amenable to the administration. In any event, Powell follows in the footsteps of G William Miller in the late 1970s—a non-economist appointed in preference to a sitting Chairperson.
The good news is that Powell has sat on the seven-person Federal Reserve Board since 2012. He has a background in investment banking and financial markets, and has worked at the Treasury. He has been a reliable ally of Yellen, never voted against her, and been a solid consensus type of a governor in the mold of both Yellen and her predecessor Ben Bernanke. He’s very likely a proverbial “safe pair of hands,” occupying the middle ground when it comes to the Fed’s principal functions at the current time, setting interest rates, unwinding over $4 trillion worth of assets that the Fed accumulated under the quantitative easing programme, and financial regulation.
All in all, Powell’s appointment seems uncontroversial and it is. But that could be the problem—for three reasons.
First, some Republican politicians may want to constrain the Fed, limit its autonomy or pressure it on financial deregulation. In recent decades, Alan Greenspan, Bernanke and Yellen have all turned out to be skilled central bankers as well as consummate political operators, relying on their deep economic expertise and reputation to fend off assaults on their positions and on the Fed. Powell will have to up his game to compete, especially when it comes to keeping at arm’s length some of the more radical Republican proposals to unravel financial regulation.
“Every Fed Chair has had to manage a crisis, and Powell will doubtless have his”Second, as a non-economist, Powell will be at a disadvantage when it comes to dealing with random or quirky economic developments. Even though many central bankers have been struggling to understand the current economic environment, let alone predict future events, it is important for them to think aloud and communicate effectively the key drivers of monetary policy in a complex economic environment. In the US, a lot of people look to the Fed Chair for guidance about the challenges of low inflation, wage gains and productivity, and when things might finally start to change. The Chair will also have to articulate the monetary policy consequences of Washington’s tax reform agenda that could become law in the spring of 2018, and that could give the US economy another push on, for a while at least. Powell will have to up his game here too, with support from his economics colleagues, possibly including Yellen who can stay on as a governor for several years yet if she likes.
Third, and most importantly, every Fed Chair has had to manage a crisis, and Powell will doubtless have his. Paul Volcker (1979-87) had to weather a deep recession, the savings and loan crisis, and conquer surging inflation. Greenspan (1987-2006) had to manage the Fed through two recessions and the Asian crisis. Bernanke (2006-14) had to contend with the financial crisis and its aftermath. Maybe Yellen would have had her crisis had she stayed on, but the next one will be on Powell’s watch.
And that’s where his training comes in. It’s not enough to form a consensus for incremental rate setting, when you have to understand something about the plumbing of the economy and financial system in an emergency. Over the next two-three years Powell’s biggest challenge, at least as far as we can predict, is how and when he will bring the current expansion, likely to be extended by tax cuts, to an end without tipping the economy into a black hole.
On taking office, subject to being vetted by the Senate, Powell will inherit a Fed that has raised interest rates four times in steps of 0.25 per cent since the end of 2015. A fifth increase is expected in December. Market traders think Powell’s Fed will raise interest rates once or twice in 2018 but this is hostage to sentiment, whether the economy, now growing at about 3 per cent, can continue on this path, and what happens to inflation.
“Powell’s biggest challenge will be bringing the current expansion to an end without tipping the economy into a black hole”The inflation picture has many central banks and central bank watchers confused. In the US the core rate of inflation, excluding food and energy, and the Fed’s preferred measure, the core personal consumption deflator (a broader measure of inflation) have been drifting down this year to about 1.3-1.5 per cent. Yet the headline rate of consumer price inflation, which has struggled to exceed 2 per cent, popped over the line to reach 2.2 per cent in September, and wages may finally be stirring. According to at least two of the Federal Reserve’s 12 regional banks, Atlanta and San Francisco, measures of wage inflation are now at their highest levels since 2008, and rising at about 3.5-4 per cent—much faster than the data published by the Bureau of Labour Statistics every month suggests.
If Powell takes over against a background of more lively economic, wage and inflation expectations, the Fed’s interest rate and balance sheet reduction agenda will move centre-stage. Powell will then have to stand up to the administration and raise interest rates a little faster, or sacrifice the Fed’s credibility by not doing so. If he buckles under political pressure, US financial markets will be in trouble. If he doesn’t, he will need a game-plan at home for dealing with a possible 2019 recession, and abroad for addressing the fall out of higher rates and a stronger US dollar for emerging markets.
This isn’t to say a lawyer can’t rise to the occasion. But just as you’d rather have a physicist dealing with a nuclear plant emergency, so it would be better to have a good economist at the helm in this case.
