Economy & Business

Jay Powell Has a Dilemma

Federal Reserve Chairman Jay Powell (Al Drago/Reuters)
And it has little to do with monetary policy

The chairman of the Federal Reserve is having a moment, which tends to be a bad sign. Paul Volcker became a household name for pushing the overnight interest rate up to 20 percent during the inflation of the 1970s, Alan Greenspan famously puzzled over the decline in long-term interest rates as he raised short rates in the lead-up to the financial crisis, and Ben Bernanke was much-watched as he embarked on an ambitious program of quantitative easing to inject liquidity in the economy and boost asset prices after the 2008 crash. The lesson: When monetary policy is in the news, there’s something foreboding afoot. Now all eyes are on chairman Jay Powell as the Fed decides whether to raise the policy rate another 25 basis points (0.25 percent) at this week’s meeting of the Federal Open Markets Committee.

The Fed began its meeting on Tuesday, and its decision will be announced on Wednesday. Of course, the stakes of this decision are far lower and the challenges faced by this Fed are far less severe than they were for Volcker in the late ’70s, Bernanke in the late ’00s, or European Central Bank (ECB) head Mario Draghi during the European debt crisis in the early ’10s. Powell’s decision won’t be the difference between prosperity and recession. But it nonetheless comes at a fraught political moment, carrying consequences for the perception of the Fed’s independence. Policy concerns aside: If Powell hikes rates, he could face Trump’s wrath; if he doesn’t, he could lose his credibility.

The policy rate — the overnight rate at which banks lend to one another — is one of the Fed’s main levers to achieve its mandates to maintain price stability and to maximize employment. (The other main lever is asset purchases, and the Fed also plays an important role in regulating the financial sector.) It currently sits at 2.25 percent, up from zero in late 2015 as the Fed has continued the process, begun by Powell’s predecessor, Janet Yellen, of gradual interest-rate hikes during the ongoing economic expansion. As it raises rates, the Fed has also wound down its balance sheet by allowing billions of dollars in Treasury bonds to expire each month. For months now, it has sent strong signals that another rate hike was to come this month. In October, Powell said interest rates were “a long way” from neutral.

The Fed changes rates and adjusts the size of its balance sheet to stimulate the economy when it cools down, or to put the brakes on it when it heats up. Whether it ought to favor one prong of its dual mandate, or whether it ought to set a broader goal, is a matter of dispute. Populists argue that the Fed should pursue a looser policy to encourage a healthy labor market, hard-money hawks argue that it should prioritize keeping inflation under control, and market monetarists argue that the Fed ought to aim to ensure a stable path of nominal-spending growth.

Despite these disputes, however, the Fed has operated for decades without much political interference. Ronald Reagan and George H. W. Bush occasionally expressed frustration with the central bank, and the wisdom of central-bank independence is a question all its own — but the fact remains that no president in the modern era has pressured the Fed as much as Trump, who in recent months has called Powell’s actions as chairman “crazy” and publicly implored it to pause its rate hikes. Briefly, the case against such interference is twofold: Politicians tend to disregard inflation concerns for political, not economic, reasons; and markets tend to recoil from central bankers they perceive to be unreliable.

Trump hasn’t bothered to make a coherent case against Powell, saying instead that he relies on his “gut” to make monetary-policy judgments. But he isn’t alone in opposing further hikes. Since November, two Fed governors have said in public comments that a pause would be prudent. On the eve of the Fed’s meeting this week, the Wall Street Journal editorial board and former Fed governor Kevin Warsh called on the Fed to hold off on a December rate hike. A former inflation hawk who was a finalist for Powell’s job, Warsh argues that the effect of the Fed’s balance-sheet reductions “has been exacerbated as central banks withdrew overall liquidity from the market,” alluding to the ECB’s upcoming end to its asset purchases. He calls on the Fed to end its “double-barreled blitz” of rate hikes and “quantitative tightening,” which, the Journal argues, comes at a time when inflation is under control, the junk-bond market is showing cracks, the trade war is dampening investment, and the housing and automotive sectors are softening. Skittish equity markets, a flattening yield curve, and complacent asset valuations only add to the reasons for caution.

So what will Powell do? The market-implied odds are still in favor of a rate hike. But he’s feinted in a more dovish direction in recent weeks, saying in November that rates were “just below” neutral. That might not seem like much, but central bankers choose their words carefully. Investors pore over their public comments like rabbis over the Talmud. What Powell does tomorrow is as important as how he explains it.

The smart bet is that the Fed will split the difference, hiking rates tomorrow but delivering comments that strongly imply — both to markets and to the president — that it has reevaluated its projection of three more rate hikes in 2019. Powell has said that the Fed will pay less attention to theoretical models and more attention to real-world economic data when making decisions. That seems to suggest a split decision: The relationship between inflation and labor markets indeed ain’t what it used to be, there are legitimate forward-looking concerns about liquidity in emerging and developed markets, and a yield curve that continues to flatten may affect investor behavior. But the Fed doesn’t exist to prop up financial markets, growth in the U.S. remains reasonably strong, and the labor market has shown no signs of turning down.

All that’s certain about Wednesday is that Powell won’t say that Trump’s pressure had anything to do with his decision. That’s for good reason. A Fed chairman’s credibility is his most important currency. If Powell decides not to hike rates, he’ll marshal evidence that he says counts in favor of the move. The question then becomes whether the press and the markets believe him.

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