What to Expect from Chair Powell

We said early this year (in March!) that Powell could be named Fed Chair. Recently, we raised him to the top of our list. (See Trump’s Fed Nominees: What Does He Want, What Will He Get? and Good News: Powell  Moving Up in Race for Fed Chair

Trump went for continuity with respect to monetary policy. Not surprising. 

With regulation, he went for someone he might have thought offered change, more in sync with the  Republican agenda. Powell does stand out as someone more committed to and more enthusiastic about deregulation than Yellen is—but, like Yellen, he prefers modest deregulation and, most importantly, retaining the core elements of post-crisis legislation that improved the resiliency of the banking system. But Powell is still far away from Trump’s deregulation agenda, whatever it is! He is especially focused on reducing the burden on small- and medium-sized banks and also on a simplification and recalibration of the Volcker rule, all championed by Republicans. But these were coming in any case. Congress will be a partner in this effort,  not an adversary. 

Like Bernanke and Yellen, he will respect the consensus-oriented FOMC decision-making process and work skillfully and tirelessly to build, recognize, and communicate the consensus—but with a difference. He might not be able to shape the consensus by persuasion to the same degree that they could. 

I see monetary policymakers as more likely to adjust to very adverse developments more quickly, more aggressively, and, if appropriate, with more innovation when the Chair has spent a career studying macroeconomics and is seen as a monetary policy expert. 

Having said that, Powell has successfully internalized the consensus paradigm about how the macroeconomy works and the transmission mechanism. He does know his stuff! His judgment is respected inside the  Committee. Still, Powell will be more dependent on the Fed staff for recognizing shocks and developing appropriately calibrated policy responses. Inside the FOMC, experts are highly valued! 

A centrist to be sure, though you can’t conclude that by the absence of dissents. Governors rarely dissent!  But he is the consummate team player, and I don’t believe he would ever have dissented under Yellen. 

Still, where would he have been without Yellen’s lead? My guess is more cautious, less aggressive with respect to the speed and degree of monetary accommodation after the financial crisis. He is experienced with unconventional policies and committed to using them at the zero bound. But, given the initial conditions and forecast, I don’t see any change in the course of monetary policy in the near term. 

He is more politically savvy in terms of being able to work well with and be respected by Congress, helped by his experience with Congress while at the Bipartisan Policy Center. He sees them as a partner in deregulation, not an adversary. 

While he didn’t talk often, he was thoughtful, guarded, stuck to the consensus, and was a master of the  Q&A. He will be an excellent communicator

All in all, Powell’s views are squarely in line with the consensus on the Committee with regard to the current course of monetary policy; the benefits of (but limits to) relaxing regulatory burden on banks; the value of rules in informing judgment of monetary policymakers, but the absolute need (in the end) for discretion; and just about everything else. But there is perhaps a lone exception: He appears to have less confidence in the effectiveness of macroprudential policy and, therefore, possibly sees a greater role for monetary policy in responding to a buildup of risks to financial stability. 

But the bottom line is that this change in leadership doesn’t necessitate a change in our monetary policy call because I expect Powell will support the same policies over the near term that Yellen would have. However,  it is too early to judge the effect Trump will have on the course of monetary policy. We will have to assess that as Trump makes four more nominations to fill vacant seats, including, most importantly, that of the vice-chair. 

Powell’s Macro Paradigm and Implications for Rate Policy 

Powell toes the Fed party line on the prevailing Phillips-Curve/slack framework. 

August 26, 2016: “And what’s happened is that there’s something called the wage Phillips curve. So as the labor market tightens, then wages should go up. And we’re just beginning to see that now. We — we’re seeing clear but, you know, not really strong dispositive evidence, though, that — that wages are moving upward. That’s good. The transmission between wages and prices has actually weakened over the past 20  years. And also—so the transmission between—between slack in the labor market and wages has weakened.  So the Phillips curve is, as we say, flat. Meaning that the connection between slack wage inflation and price  inflation is much weaker than it has been historically.” 

In June 2017, he cited the strong labor market as the force driving inflation upward. In this sense, he shared  Yellen’s views. But he also recognized the disconnect today between persistent low core inflation and a low and declining unemployment rate. Again, consistent with Yellen. And we count him in the apparently strong consensus nevertheless for a December hike, along with Yellen. 

Asymmetric Risks at the Zero Bound 

Another attitude he shared with Yellen was the attention paid to asymmetric risk caused by the zero lower  bound: 

“When you’re near the zero lower bound, you are not in the asymmetric world. I think you have to be more risk-averse because you’ve got, really you don’t have the tools to deal with the downside case. So you’ve got to do more to push away from the zero lower bound. Once you’re well away, the reaction function becomes  more symmetric.” 

This has been a core principle that has supported a later liftoff and slower pace than otherwise. Financial Conditions and Monetary Policy 

As Chair, he would pay close attention to financial conditions and recognize that sometimes there can be a  disconnect between monetary policy and financial conditions (a view championed by Dudley): 

June 1, 2017: “What matters is not the level of the federal funds rate…it’s the level of financial conditions  generally…so if [a longer-term disconnect] exists, then I think it’s something you need to take into account.”

Monetary Policy at the Zero Bound 

Powell certainly is well-positioned to lead the Committee with respect to unconventional policy at the zero bound. With respect to monetary policy, the question is whether he would be as aggressive as Yellen. Here,  an anecdote from Bernanke’s book may be telling. Bernanke strongly supported the more open-ended approach of QE3, but that made some of his colleagues uneasy. This example shows the limits of the Chair’s influence and the importance of building a wide consensus, especially for a controversial decision like this. 

Ben S. Bernanke, The Courage to Act: A Memoir of a Crisis and Its Aftermath (New York: Norton, 2015): “I  was particularly concerned that I could lose the support of three Board members: Jeremy Stein, Jay Powell,  and Betsy Duke…My position as Chairman is untenable if I don’t have the support of the Board.” 

This story is relevant to Powell in two ways. First, even for a persuasive Chair like Bernanke, the Committee can sharply constrain the Chair’s ability to shape policy. Of course, more so for Powell. Second, this story might also be consistent with my impression that Powell would be more cautious than Yellen with respect to monetary policy. 

Balance Sheet Policy 

Powell made clear that he favors maintaining the current floor system, and this choice has implications for the size of the normalized balance sheet. (See Powell Updates Guidance on Balance Sheet Plans.

June 1, 2017: “A ‘floor system,’ is simple to operate and has provided good control over the federal funds  rate…[The] ‘corridor’ framework remains a feasible option, although, in my view, it may be less robust over  time than a floor system.” 

An important reason that the current system is more “robust” is that the pre-crisis system is incompatible with carrying out asset purchases when the funds rate hits the effective lower bound. This carried over to what he envisions as the size of the normalized portfolio. In concrete terms, he said it was hard for him “to  see the balance sheet getting lower than 2.5 to 3 trillion.” Indeed, “if you’re going to have a floor system,  reserves have to be abundant.” 

He has talked explicitly about the interaction between rate hikes and balance sheet reduction—more so than  many of his colleagues: 

June 1, 2017: “When we reduce the balance sheet, that will increase debt held by the public, which could put upward pressure on long-term rates. To the extent that happens, we have to take it into consideration.  But the effect would be rather small.” (Source: CNBC) 

When pressed on whether the median longer-run dot, 3% at that time, already had taken into account  the implicit effect of balance sheet normalization on the appropriate rate path of the fund’s rate, and specifically  on the neutral fund’s rate, he said that “the 3% already assumes an increase [in the term premium] over time.” 

For now, Powell will be happy that the decision on phasing out reinvestment is behind him, proceeding smoothly in the background, so he only has to think about rates. 

As for the possibility of expanding the balance sheet in the future, should economic conditions warrant, he  described it as a policy tool to be used “only in extraordinary circumstances?” Again in line with the consensus on the Committee. 

Financial Stability, Macroprudential Policy, and Rates 

The one place where I see a possibly different view from the consensus on the Committee and the official  position that emerged after Greenspan, under Bernanke and Yellen, is in Powell’s discussion of the link  between low rates and financial stability: He appears to have more concern about the efficacy of 

macroprudential policy and pays more attention to the possibility we may be getting close to a point where monetary policy might have a role. 

The official position of the Committee, promulgated by both Bernanke and Yellen, is that, while the Fed is very much concerned with mitigating risks to financial stability, macroprudential policy is the first line of defense. This is usually stated as a tradeoff between promoting the dual mandate and responding to financial  stability risks; Powell, even if implicitly, links elevated risks to the conduct of monetary policy: Risks become  elevated when rates are “low for long.” 

May 2016: “Macroprudential and other supervisory policies are designed to reduce both the likelihood of such an outcome and the severity of the consequences if it does occur. But it is not certain that these tools would prove adequate in a financial system in which much intermediation takes place outside the regulated banking sector. Thus, developments along these lines could ultimately present a difficult set of tradeoffs for monetary  policy.” 

Powell also appears more focused on excessive risk-taking and unsustainable asset prices in the markets,  whereas the consensus on the Committee seems to focus mostly almost exclusively on financial stability risks coming from systemically important banks–hence the focus on macroprudential policy. His wider focus on financial stability risks and a sense he might favor a monetary policy response while the risks are building,  and before they become more acute, seems evident from the fact that in his discussion he cited Jeremy Stein,  who holds similar views. 

January 2017: “Low-for-long interest rates can have adverse effects on financial institutions and markets through a number of plausible channels, as listed on the next slide. After all, low interest rates are intended to encourage some risk-taking. The question is whether low rates have encouraged excessive risk-taking through the buildup of leverage or unsustainably high asset prices or through misallocation of capital. That  question is particularly important today.” 

The first step is monitoring. What does that tell him today? A “mixed” bag but not yet at the point where a  monetary policy response might be called for. 

“The picture is mixed, but the bottom line is that there has not been an excessive buildup of leverage, maturity  transformation, or broadly unsustainable asset prices.” 

In June, he said that financial markets were not “at very toppy levels” and he didn’t “see credit growth above  its longer-run trend.” 

Powell may see himself as having a comparative advantage in understanding financial markets, reflecting his experience at Carlyle, and, as a result, might be more forceful with respect to the assessment of financial stability risks and the policy response. 

The Inflation Objective 

He doesn’t seem to have any appetite for signaling changes to the inflation objective: “For working central  bankers, it’s 2 percent, and we’re committed to that.” Yet Williams and Harker have discussed this as a  serious possibility, and even Yellen seemed to recognize it as something that might be considered in the future. Powell will take a firmer position: 2% objective, period! That is it, for now! 

On policy rules, Powell regarded them as “interesting and useful” but ultimately insufficient for assessing the correct rate path, nothing that it would be tantamount to reducing it to a “simple summary equation,” in line with the overwhelming consensus inside the Committee. 

Productivity Growth and Pro-Growth Fiscal Policy 

More recently, Powell sounded a warning on “very low” productivity growth, noting that the “biggest challenge” is increasing potential growth. Trump may take comfort from that, but this is an obvious 

conclusion, shared by all Committee members. Of course, he appreciates that monetary policy cannot be used to raise potential growth and that this is a question of fiscal policy. But, to be sure, he is likely not a wild-eyed supply-sider who thinks you can cut tax rates and reduce the deficit at the same time. Not a prayer. 

Rollback of Regulations after the Financial Crisis 

Powell is committed to regulatory reform that reduces the regulatory burden, especially for small and medium-sized banks, and in all cases holds that regulations should pass the cost-benefit test. His views are seen as more in line with the traditional Republican perspective, but his support is for modest deregulation and falls way short of what the Administration is apparently looking for. In addition, he is committed to retaining the core elements of post-crisis regulations. These views do not differ from Yellen’s, but he is understandably seen as more committed to this modest deregulation because of the enthusiasm he shows for it and also,  undoubtedly, because he’s a Republican! 

He also called for differentiated treatment of small- and medium-sized financial institutions: “we try hard not  to add excess burdens…but it’s a constant battle…we really do believe we can do a lot more on that.”  Nevertheless, he argued that U.S. capital standards “are about right now…don’t see them as clearly too  high or too low.” Regarding international regulation, he wanted to see Basel III completed by year-end. 

He wants to see “simplification” and “recalibration” of the Volcker rule. Indeed, he said in recent testimony: 

“There’s significant flexibility to make the Volcker Rule more effective and more efficient, even for the largest institutions and certainly for the smaller ones.” 

He cited a “five-agency” review of the Volcker Rule, which would play to his strengths in the financial regulatory world and interagency cooperation. 

But, like Yellen, he always emphasizes that it is essential to retain core elements of post-financial-crisis  regulatory changes: 

“It’s essential that we protect the core elements of these reforms for our most systemic firms in the capital,  liquidity, stress testing, and resolution.” 

Bottom Line 

Powell is a safe choice. An Excellent choice, who will provide continuity with respect to monetary policy. His selection reinforces that changes are coming with respect to regulatory policy, though his views are not much different from Yellen’s, and far away from an aggressive approach favored by many Republicans. Perhaps a  bit more caution in terms of aggressiveness with respect to both rate policy and balance sheet policy. And he’ll have less ability to shape the consensus than Bernanke and Yellen. Powell as Chair has no implications for our call for monetary policy ahead: Gradual move toward neutral, with a relatively steady hand. One difference is how he may see the balance between macroprudential policy and rates policy when financial stability risks are seen as building. 

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