What does it mean to be the “continuity” candidate in a time of uncertainty and change?
That’s the question Congress (and the rest of the country) finds itself facing with President Trump’s nomination of Jerome Powell to chair the Federal Reserve Board on Thursday.
In the run-up to the announcement, many key observers considered Powell a relatively safe pick. After all, he is a known quantity with no record of dissent with the Board of Governors, who may continue current Chair Janet Yellen’s strategy.
A decade after the financial crisis, however, the Fed continues to struggle with inflation rates below its 2 percent target, has just now begun the complex process of unwinding its $4.5 trillion balance sheet and has yet to seriously address persistent concerns about interest payments on excess reserves.
While monetary policymaking independence is a hallmark of the Fed and worthy of preservation, Congress’s oversight role should prompt questions about what continuity means when so many aspects of monetary policy remain unclear.
First among those questions should be whether Powell views the 2-percent inflation target as a true “target” or a “ceiling.” Despite their public positions, both the Federal Reserve and the European Central Bank have treated the inflation target as a ceiling, content to consistently miss that target during the entirety of Yellen’s tenure so long as inflation remained stable.
In a speech earlier this year, Powell explicitly reiterated that the Fed’s inflation target was “symmetric,” meaning they should feel the same whether inflation runs a little higher or a little lower than their target.
If that’s the case, he should be prepared to explain to Congress why the board feels that monetary policy can’t or shouldn’t boost price levels further, or why he expects inflation to rise on its own given current Fed policy.
The Fed’s November statement also offered little update on its balance sheet normalization program, other than to note that it “is proceeding.”
A unanimous vote from the Fed to begin shrinking the balance sheet in September masks the complexity of actually following through on that promise. The reality is that the Fed (and, by extension, the rest of the economy) is still on uncertain ground.
What indicators might cause Powell to slow down the process? How far does Powell think the unwinding should go? The Fed has been quiet so far about its real endgame.
In his June speech, Powell estimated a more “normal” balance sheet to be somewhere between $2.4 and $2.9 trillion by 2022. That may or may not be in line with congressional expectations.
We also don’t have much clarity about the future of the Fed’s interest payments on excess reserves. Those payments began as a way to manage the increase in bank reserves that accompanied a growing Fed balance sheet, and the issues remain somewhat entangled.
Part of unwinding the balance sheet is likely to involve banks trading excess reserves for treasury bills, which would allow the Fed to pull those reserves out of circulation while still providing banks a relatively safe, liquid asset in order to meet their regulatory requirements.
As other economists have observed, however, the Fed’s artificially high interest payments might cause banks to resist trading those reserves for lower-yield treasuries.
Is Powell prepared to lower interest payments on excess reserves to Treasury-bill levels in order to prevent that potential disruption in the market?
“Continuity” is a helpful marker when the current path is clear and predictable. The current uncertainty surrounding the Fed’s path forward makes it less helpful for Powell. The good news is that, as with any transition, Powell now has the opportunity to clarify these (and other) lingering questions.