Jerome Powell, as you ascended to the role of chairman on February 5, commentators have generally concluded that you will be a clone of your predecessor, just as Janet Yellen was of hers. Were simple extrapolation the primary means of viewing the future, it’s hard to take issue with that consensus view.
In fact, the script seems written in stone. An April 2017 study, “The Economics of the Fed Put,” analyzed the period from 1994 – 2016. It concluded that negative intermeeting stock market returns are a stronger predictor of subsequent target changes in the Fed funds rate than any commonly followed macroeconomic variable. No analogous relationship existed for positive returns. Using textual analysis of FOMC minutes and transcripts, the study concluded that stock price movements cause Fed policy changes. It appears the Fed believes the stock market is a driver of the economy. The wealth effect projected by a rising market was emphasized as a driver of consumption. Such sentiments theoretically stimulate capital expenditures and reduce the cost of capital.
Still, you don’t strike me as the prototypical cut-of-the-same-cloth Fed Chairman. Neither an academic, nor an economist, nor a left-leaning Keynesian, you bring different experiences and skill sets the job, one you could hold until 2028. A 1979 law graduate from Georgetown, most of your career has been in the private sector as an investment banker. Even your indoctrination at the Fed, which dates back to 2012, is conspicuously brief by Janet Yellen’s standards. Parenthetically, you were no doubt as surprised as Yellen when her tenure as chairwoman was, without recent precedent, terminated by Pres. Donald Trump after just one term.
In October 2012, as a newbie to the Fed board, you caught my attention when you indicated you recognize the importance of inflation in real and financial asset markets. “I think we are actually at a point of encouraging risk-taking, and that should give us pause.” The S&P 500 index was 1412.
To be sure, you have comported yourself as a consistent moderate, backing the consensus crafted by Janet Yellen that interest rates should be raised slowly so that labor markets can recover, that risks to financial stability are muted, and that new regulations make the economy safer.
Most recently, though, on January 7, 2017, in a speech at the American Finance Association, you seemed to step out of that centrally casted character, almost coming across as an iron fist in a velvet glove: “The bottom line is that there has not been an excessive buildup of leverage, maturity transformation, or broadly unsustainable asset prices…Overall, I do not see leveraged finance markets as posing undue financial stability risks. And if risk-taking does not threaten financial stability, it is not the Fed’s job to stop people from losing (or making) money.” As for the losing part, that’s blasphemy to “The Economics of the Fed Put.” Of course, you were free to exhibit a little originality given yet no inkling that you would be sitting in Yellen’s chair one year hence. The S&P 500 was 2,274.
Deep down, Mr. Powell, are you more like your fellow inductee from 2012, Jeremy Stein—the economist and noted Harvard academic? Stein was outspoken and quit the Fed after just two years, ostensibly to preserve his tenured professorship. He raised Yellen’s ire by arguing that the Fed should temper its efforts to minimize unemployment because those policies encourage financial risk-taking, which can undermine long-term growth by destabilizing markets and causing new crises. His views remain controversial. Many of Mr. Stein’s colleagues have said that they see no signs of dangerous overheating in financial markets. Some critics say Mr. Stein was focused on the last crisis instead of the present problem: high unemployment.
There is continued debate over the raising of interest rates as a prescription for overheated financial markets. Many officials regard that as a crude approach because the effects are felt throughout the economy. Mr. Stein, however, saw this as a potential benefit; higher rates could potentially solve problems that regulators have not noticed.
Mr. Powell, I have no doubt that you understand how central banks can fuel asset bubbles and, as noted above, you have obliquely expressed concern from time to time over the Fed’s role in distorting the pricing of financial markets. You may not have been nearly as controversial as Jeffrey Stein, but by toeing the line you have maintained your job and been promoted to top dog at the Fed to boot.
Besides, we all understand the heat central bankers take in the business media when talking down the markets. In 1996 Alan Greenspan uttered his “irrational exuberance” comment and was roundly criticized. So much so that he backed down. Ben Bernanke was behind the curve in 2006 when he opined that problems in subprime would remain contained. Thus, he escaped any criticism. The easy money spigot was essentially turned wide open shortly thereafter until he passed the hot potato to Janet Yellen in 2014. Yellen knew about Greenspan’s misstep with the press and avoided making hawkish noises to the very end.
Rather than opening acknowledging structural weaknesses in the economy when it fails to meet whatever metric the Fed has previously targeted, the FOMC instead simply revises its expectations without explanation. It appears that we could just shoot of economic performance onto a blank canvas and then carefully draw the bulls-eye around the implanted arrow.
For instance, in January 2012 the Fed’s long-run view of the “median terminal funds rate” was 4.25%. In a stair step pattern, the Fed continues to repaint the bulls-eye: by December 2017, it had ratcheted it down to 2.75%. As you know, Mr. Powell, that rate is a critical element in determining the present value of all manner of earning assets. That is, as we both know, precisely how bubbles inflate.
Yet another example of redrawing the bulls-eye is the NAIRU (non-accelerating inflation rate of unemployment). It has also been on a downward slope from the stated target of 5% in June, 2015, to 4.6% in December 2017. With the actual unemployment rate now at 4.1%, is it any wonder that a whiff of inflation is in the air?
Perhaps that target has taken precedence and spurred revisions of others. Specifically, the Fed has been fixated on seeing 2% core inflation (the PCE deflator is their favored metric) which, except briefly in 2012, has been stubbornly elusive. In 1966 Janet Yellen asked Alan Greenspan for his definition of price stability and he replied, and I believe correctly, zero. Why maintain dogmatic adherence to such an arbitrary level that all other metrics are revised accordingly?
Is it possible, Mr. Powell, that the Fed is, in military jargon, knowingly tracking the wrong bogeys and, all the while, its overarching policy mandate is to forever inflate the capital markets? We all await anxiously to see how you will stage this next act and how long you believe that goal is sustainable.