A New Fed Chairman for a New Economy
The day has finally arrived. Jerome Powell has been sworn in as the new chairman of the Federal Reserve, replacing Janet Yellen, who had served as the chair of the Board of Governors since 2014. Powell was nominated by President Donald Trump in November and was recently confirmed by the U.S. Senate after Trump refused to reappoint Chairwoman Yellen to a second four-year term. He’ll take the helm of the central bank at a time of dramatic correction for the world economy; the Dow Jones Industrial Average sagged 4 percent on Monday, partially in response to anxiety over the Fed’s schedule of interest rate hikes.
As head of the Fed, Yellen oversaw American monetary policy during a very delicate period. When she took office four years ago, the economic recovery was still weak and the shadow of uncertainty still hung over the U.S. economy. Yellen was faced with two significant challenges. On the one hand, she was responsible for supervising the end of quantitative easing (QE), the unconventional monetary stimulus policy started by her predecessor, Ben Bernanke, in 2009. On the other hand, in coordination with the Federal Open Market Committee (FOMC), she had to bring about the so-called normalization of short-term interest rates, which had remained at zero level since early 2009.
During Yellen’s tenure, the economy has gotten back on track. Even though GDP growth has not been particularly strong over the last several years (it is expected to accelerate in 2018), the unemployment rate has dropped by almost 40 percent and inflation has remained nearly on target. However, as exemplary as Yellen’s track record may seem, assessing the performance of Federal Reserve chairs can only be undertaken after a reasonable period of time. When Alan Greenspan quit in 2006, he was widely praised for his impeccable track record as head of the Fed. We all know what happened shortly thereafter.
In any case, it seems obvious that Powell will take the reins in a radically different economic situation. What can we expect him to do at the Fed? Powell was initially nominated to the Board of Governors by President Obama in December 2011, and took office six months later. Prior to that, he had spent most of his professional career in the finance industry, except for a three-year stint when he worked in the Department of the Treasury during the George H. W. Bush administration.
When Powell, a lawyer by training, joined the Fed, his knowledge on macroeconomics and monetary policy was rather limited. Hopefully, five years as a board governor will have provided him with a solid training in the challenging task of making sensible monetary policy decisions. Powell has often sided with Yellen in her dovish approach towards monetary policy, though not always. In 2012, he voiced concerns about the expansionary policy the Fed was implementing at the time, warning about the potential costs of prolonging QE.
Whether a hawk or a dove, Powell will have to face several challenges in the upcoming years. In the short term, he is expected to continue with the interest rate hikes that Yellen initiated in December 2015. Depending on how the economy evolves in the following months, the Fed might be forced to increase rates at a higher speed than planned if it aims to maintain its price-level target. In addition, Powell will be compelled to tackle the issue of the inflated Fed’s balance sheet, which grew enormously in the aftermath of the crisis and has remained practically flat since 2014.
In the long run, Powell should stimulate a process of internal reflection that leads to legislative changes aimed at reframing the Fed’s dual mandate, which calls on the bank to both maximize employment and keep prices and interest rates stable. The Great Recession laid bare the weaknesses of price-level targeting as a reliable tool of monetary policy. Some economists have instead suggested adopting nominal GDP targeting as a rule that would provide macroeconomic stability while coping better with shocks in aggregate demand.
Be that as it may, Powell is bound to become the new key figure in the shaping of the monetary policy of the post-Yellen era. The normalization of interest rates, the unwinding of the Fed’s balance sheet, and the reassessment of the dual mandate are the issues that will mark his first term as chairman.
Luis Pablo de la Horra holds a MSc in Finance. He’s currently doing a Master of Research in Business Economics, prerequisite to start a Ph.D. in the same field in 2018. He has been published by CapX, Speak Freely, and the Foundation for Economic Education, among others.