On Monday morning, President Joe Biden made the most important hiring decision of his first term, at least so far as the economy is concerned: He announced he would be reappointing Jerome “Jay” Powell as chair of the Federal Reserve. Lael Brainard, a fellow Fed board member widely rumored to be the runner-up for Powell’s job, would be tapped as vice chair.
The Fed is perhaps the most underappreciated policymaking body in Washington. It sets what’s known as the federal funds rate, which determines the cost of borrowing for banks and, in turn, can raise or lower interest rates for business loans, credit cards, mortgages, cars, and so on. By raising rates, the Fed can reduce borrowing and spending, slow the economy, and prevent inflation; by cutting them, it can boost spending and reduce unemployment, and possibly raise prices. When it needs to, it can buy US Treasuries and other bonds with money it prints out of thin air to give the economy a boost.
Only Congress rivals the Fed’s power to determine the course of the economy — and the Fed is able to move much quicker than Congress ever could.
Powell, who was first put on the Fed board by President Obama and made chair under President Trump, is expected to breeze through the Senate confirmation process, with both the top Democrat and top Republican on the Senate Banking Committee praising the pick.
This is news worth celebrating. As the economics writer Alan Cole laid out in his case for Powell, the chair’s first four-year term has seen an epochal shift in monetary policy, away from a singular focus on preventing inflation and toward aggressively attempting to get unemployment as low as possible.
That focus is, of course, being tested now that inflation is spiking, and Powell’s second term may require a more aggressive stance toward price increases. That this is the dilemma we find ourselves in is a testament to the fact that Powell helped cut the US unemployment rate by more than two-thirds since it peaked last April.
Powell’s innovation as Fed chair was to really care much more about employment, relative to inflation, than his recent predecessors had.
In 2019, he began lowering interest rates during an economic expansion, a genuinely unprecedented action that conceded the rate hikes he introduced the previous year were a mistake.
In 2020, he issued a new formal framework explicitly pushing the Fed away from its traditional fixation with inflation and toward worrying about employment.
He made these changes in the context of a world where inflation was consistently low and employment and wages were short of where they should’ve been. But in 2020, and especially 2021, the tasks before Powell changed. First he had to prevent a pandemic-driven collapse of the global financial system akin to what occurred in 2008.
Then he was — is — faced with the question of what to do now that inflation is high for the first time in decades. That challenge, and the question of whether Powell can be as effective at controlling inflation as he has been at promoting employment, will frame his next term.
How Powell saved the day in 2020
Powell was masterful in his response to Covid-19, stabilizing global markets vastly more effectively than policymakers did during the 2008 economic crisis and aggressively lobbying for fiscal stimulus from Congress.
Just to give one example that’s often unheralded: In March 2020, as the pandemic set in, the world saw a massive exodus of investments from low- and middle-income countries, a phenomenon known as “flight to safety.”
By March 24, 2020, foreign investors had pulled $78 billion from emerging market economies, a greater amount than they had put in in all of 2019. It was the worst outflow on record, worse than during the 2008 financial crisis.
Left unchecked, this could have led to a much worse economic crash across the world than actually happened. When this kind of capital flight occurs, it devastates the economy of the country being fled from, weakens the value of their currency, and makes it harder for the country to borrow. This can lead to sovereign debt crises of the kind seen in Greece, Spain, and Italy a decade ago, or in Argentina in the early 2000s (when it wound up defaulting on its debts).
That did not happen in 2020. By the end of the year, the outflows from emerging economies had not only been entirely reversed, but there were massive inflows to emerging market economies. What happened? Fed Chair Jay Powell happened.
Powell worked closely with counterparts at other central banks, especially the People’s Bank of China, to establish what are known as “swap lines.” These are facilities that let poor countries trade assets denominated in their own currencies (like Mexican pesos, or the Brazilian real, for example) for dollar-denominated debt, usually US Treasuries. This stabilizes the local currency and ensures the country has access to dollars, which developing countries need to pay their debts and buy key goods like oil.
The US has offered swap lines in the past, most notably in the 2008 crisis, but it brought them back at huge scale in 2020, as did the People’s Bank of China. The European Central Bank and Bank of Japan made the most expansive use of swaps, but they were available to select emerging markets like Brazil and Mexico too. The People’s Bank had ties to dozens more central banks that let even more countries have zero-risk access to dollars.
The result, a Federal Reserve Bank of St. Louis analysis found, was that while non-dollar currencies were largely in free fall before the swap lines were announced, the Fed action stabilized them very rapidly.
Why I’m okay with an inflation dove during high inflation
The next year will likely feature the largest-scale inflation the US has experienced in three decades. Despite that, an inflation dove like Powell still seems like the best person to lead the Fed.
A chair less committed to full employment, like Powell’s rumored rival for the position Raphael Bostic, might take rising inflation as a reason to hike rates immediately. And a skeptic might wonder if Powell is to blame for that inflation in the first place, making him the wrong person to control it.
That’s a fair perspective. But policymaking is all about weighing the risks and benefits of different ideas, and on balance, my fear of raising rates too soon continues to outweigh my worries about long-run inflation.
As Skanda Amarnath and Alex Williams, two sharp economic analysts at the group Employ America, recently noted, our current inflation is the result of businesses not being able to keep up with the higher-than-expected incomes and spending of Americans coming out of the 2020 downturn.
That is, in a sense, Powell’s fault — but in another sense he’s the victim of his own success. Our inflation problem is a direct result of Powell and other leaders causing employment and spending to recover much faster than anyone anticipated.
There are two possible answers to that problem. One is to raise interest rates in an attempt to increase unemployment and/or reduce Americans’ incomes, so their level of spending better matches what corporations are able to produce.
That sounds cruel, but inflation can be cruel too, and has been high enough that many people have seen their incomes fall after you adjust for price increases. That effect has been unequal — people at the bottom of the income scale have actually seen their incomes go up a lot, while those in the middle are seeing their wages just somewhat keep up with inflation — but if millions of Americans are seeing their real incomes decline, that’s a problem. It’s not crazy to think about rate hikes in that environment.
But there’s another path: to keep spending high so that businesses are pushed to expand their capacity and produce enough to meet demand. The second road entails enduring some short-run inflation but promises a richer, more abundant America at the end. There’s a risk that short-run inflation becomes long-run inflation, but that’s a risk still worth taking given where the economy is.
And where we are is still 6 million jobs short relative to where we should be. Powell is likely to keep his focus on that problem, and that’s a good sign for the US economy, and the world’s.
What’s next for the Fed
But Powell needs help. Right now, a seat on the Federal Reserve board of governors is vacant; Republican Richard Clarida vacates his seat at the end of January, and fellow Republican Randal Quarles is resigning at the end of December.
As of February 2022, there will be three vacant seats on the Fed. While the president has made good first steps in reappointing Powell as chair and making Lael Brainard vice chair, Biden needs to nominate candidates to those three spots who will support Powell in encouraging the economic recovery and allowing some modest inflation in the coming year.
The administration promises to announce appointments for those posts in early December. I hope they keep that promise; the recovery will be stronger for it.
A version of this story was initially published in the Future Perfect newsletter. Sign up here to subscribe!