A Hint at Powell’s Personal Views on Inflation

Powell’s responses at his hearing before the House oversight committee were broadly in line with his comments yesterday. As in yesterday’s hearing (before the Senate Banking Committee), many questions from members of Congress focused on topics such as wage growth, fiscal policy, and risks from trade policy.  There were a few notable comments, however, on topics that didn’t feature prominently yesterday,  particularly balance sheet policy and the risks to the inflation outlook. 

Powell was asked about the likelihood of inflation trending upward versus downward. ▪ He started out as expected: “I would say it’s roughly balanced.” 

▪ But then he continued, “I think maybe slightly more worried about lower inflation still. But I think, for a  long time, inflation was below target, and we were pushing it. Now it’s just about reached the symmetric  2 percent objective.” 

▪ This is consistent with the idea that Powell is not a traditional Republican monetary policymaker of years past. He has taken to heart the economic research pointing to a flat Phillips curve, even if he does not always explicitly cite it. 

▪ It also hints that Powell is part of the cohort on the FOMC that thinks inflation expectations may have slipped somewhat after such a long period of below-target inflation. 

▪ This isn’t shocking, but it’s one of the rare instances when Powell has given insight into where he falls  within the Committee since becoming Chair. 

Powell was asked about the Fed’s balance sheet plans. As expected, he said that the FOMC has not settled  on a longer-run framework but will resume considering the issue seriously “fairly soon.” The biggest takeaway was that Republicans in the House appear to have become more open to the FOMC maintaining the current operating framework of maintaining abundant reserves and paying IOER. 

▪ The tone of previous hearings suggested that members of Congress might oppose efforts by the FOMC to maintain the current operating framework. In particular, there have been many pointed questions about  IOER being a subsidy to banks and a large Fed balance sheet being dangerous.  

▪ It appears that Representative Hensarling, and likely other Republicans, have become more amenable to the idea of the FOMC maintaining its current operating framework, in which reserves are abundant and  IOER is used as a primary tool to keep the fund’s rate in the desired range. 

▪ In particular, Representative Hensarling, chair of the oversight committee, acknowledged that the current consensus on the FOMC is that maintaining the current framework is likely the right decision, and he didn’t voice opposition as he has in the past. 

As for Powell’s comments on the balance sheet, they didn’t break much new ground: ▪ The balance sheet will be “no larger than it needs to be for us to affect monetary policy.” 

▪ “It will consist primarily of Treasury securities, and its ultimate size, in the long run, will be driven by the market’s demand and the public’s demand for our liabilities, principally currency and reserves. So we’re learning, along with everybody else, as the balance sheet shrinks as to what the new normal will be. And I have to say, there’s a significant amount of uncertainty. We’ll learn a lot. You know, the markets are moving their estimates up, but I don’t think we’re going to know for some time exactly what that equilibrium size will be. It will be much bigger than it was.” 

▪ “I’ve provided estimates, others have provided estimates of how long that will take [to reach a normalized size]. They’re fairly uncertain. But my estimate has been three or four years.” 

▪ When asked about whether holding MBS created a risk to the Fed’s independence and whether he would consider swapping MBS for Treasuries, he replied: “They’re dwindling overtime now. They’re in normalization mode. I don’t see them as presenting a particularly salient independence risk to us right  now.” 

▪ When asked whether the FOMC is considering a “premature end to your balance sheet roll-off plan, he replied: “No. But let’s be clear, we’ve always said that there’s significant uncertainty about how long it  will take.” 

▪ When asked what would prompt a change in the Fed’s runoff plans, he replied: “A significant downturn in the economy that required a meaningful reduction in interest rates. I think the markets understand it  very well.” ▪ He also noted that there has not been any discussion within the FOMC about altering balance sheet plans,  including by accelerating runoff, on account of concerns about the flattening yield curve. He reiterated what he said yesterday about the shape of the yield curve: He sees the level of longer-term yields as being useful in that they provide information about the neutral level of short-term rates, which helps in assessing the stance of policy. But he doesn’t see the shape of the yield curve as providing a strong recession signal per se.

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