A FINE LINE FOR THE FED - BNY Mellon
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ACCESS A BROADER MARKET PERSPECTIVE A FINE LINE FOR THE FED BY JOHN VELIS
BY THE NUMBERS 2% The Fed’s target inflation rate over the medium term* 2.2% The Fed’s projection of inflation in both 2022 and 2023, as of September 2021* 4 Seats on the Board of Governors for which President Biden will need to nominate candidates* 4.3% Current inflation based on Personal Consumption Expenditure** 5.2% Unemployment rate as of September 2021, well above the pre-pandemic low of 3.5% *** 4.7% Consumer expectations of inflation in one year, according the University of Michigan Survey of Consumer Confidence 58.5% Current percentage of persons in the U.S. employed, well below recent historical norms** $120 BILLION Current rate of monthly asset purchases by the Fed as part of its quantitative easing program* SOURCES: *Federal Reserve Board of Governors **Bureau of Economic Analysis ***Bureau of Labor Statistics
THE U.S. FEDERAL RESERVE FINDS ITSELF
IN A DIFFICULT POSITION ON MULTIPLE
FRONTS, FROM RISING INFLATION AND WEAK
EMPLOYMENT GROWTH TO UNCERTAINTY
OVER ITS LEADERSHIP, ETHICS CONCERNS
AND BANK SUPERVISION QUESTIONS.
BY JOHN VELIS
he U.S. Federal Reserve’s policy of large-scale asset purchases that In the background, inflation is
T job in steering the
economy and the health
of the financial system
is often fraught with unforeseen chal-
lenges. But as we approach the second
it is only now signaling the intention to
wind down. As we write, policy deci-
sion makers at its Federal Open Market
Committee are discussing whether to
initiate that taper as soon as November
creeping up to levels that have not been
seen since mid-2008, when core mea-
sures of inflation rose in a short-lived
burst. The Fed and many others have
argued that current inflation levels are,
year of the pandemic, it faces an unusu- this year. in the central bank’s language, “transi-
ally complicated set of issues even by At the same time, on the macro- tory” and likely to fade on their own.
central bank standards, without the economic front, the U.S. economy is We are more of the view that, after
bipartisan political support it needs emerging from a deep recession that decades of low and stable inflation, the
to address them. started with the COVID-19 pandemic. pandemic and its aftermath have cre-
The traditional remit of the Fed is to The job market is healing slowly and ated the conditions for a sustained bout
run monetary policy in a manner such remains well short of the levels of of inflation above the Fed’s target of 2%,
that the economy achieves low and employment seen before COVID hit. Fed which could last longer than the central
stable prices with maximum growth Chair Jerome “Jay” Powell wants more bank is bargaining for.
and employment. While the Fed has than a job market at pre-pandemic levels; The combination of inflationary pres-
wound down a series of special credit he has stated that he wants to see broad- sures picking up, and a labor market still
and liquidity facilities it used to quell based gains across demographic groups, well below its pre-pandemic norms,
market disturbance in early 2020, it has particularly those which have suffered could prompt the Fed to tighten mon-
kept in place an ultra-loose monetary disproportionately from the pandemic. etary policy to keep prices in check.“Even Powell himself is beginning
to acknowledge the stubbornness
of supply-side inflation…and the
labor market is not fully healed.”
How long can the Fed tolerate higher- but it often comes at the price of a bottlenecks would eventually clear up,
than-target inflation, with the economy slower economy and weak employ- the “base effects” from the post-lock-
below full employment? ment growth. Conversely, a central down reopening would fade, and infla-
The tradeoff between inflation and bank might be tempted to run a looser tion would return to sustainably low
under-employment takes place while monetary policy with the objective of levels in a matter of time.
the Fed comes under increasing scrutiny allowing economic growth to run hotter Nevertheless, as the current episode
on other fronts. A number of Federal and create more jobs, while risking of strong inflation now stretches out
Reserve Board of Governor seats are up higher inflation. longer and longer, (core inflation as
for nomination and confirmation by the Currently, U.S. inflation is run- measured by the Consumer Price Index
Senate; congressional members have ning well above the Fed’s stated goal (CPI) has been over 4% every month
criticized the Fed’s record on a number of 2% per year. The most recent data since April), the Fed has acknowledged
of issues ranging from financial system indicated that personal consumption that these supply chain bottlenecks are
regulation to global warming and ethics expenses – through August – are 4.2% persisting longer than it had initially
concerns involving senior Fed officials. higher than they were a year ago. We expected, and that inflation may stay
Chair Powell is having to navigate know that households have also regis- higher for longer than anticipated.
these pressures while at the same time tered a dramatic increase in their per- Even Powell himself is beginning
striving to achieve an appropriate mon- ceptions of inflation over the next 12 to acknowledge the stubbornness of
etary policy setting for the unprece- months. For example, the University of supply-side inflation, saying recently
dented economic conditions present Michigan Consumer Sentiment Survey during a central banking forum: “It's
in a post-COVID world. of inflation one year from now is cur- …frustrating to see the bottlenecks
rently 4.7%, its highest reading since and supply chain problems not getting
NO PLAYBOOK a brief period in mid-2008 (when oil better, in fact at the margin apparently
Since 1913, the Fed’s number one job prices were at a record high). Before getting a little bit worse.”
is to conduct monetary policy uti- that, one must look back to the early T h e F e d ’s o w n S u m m a r y o f
lizing a limited set of tools to optimize 1980s – the end of the postwar, high-in- Economic Projections, most recently
the tradeoff between low inflation flation era in the U.S. – to find such updated in late September, see infla-
and full employment. pricing data. tion ending this year at 4.2%, and
Keeping money supply tight is often Chair Powell and the Fed do not seem 2.2% in both 2022 and 2023. These
the policy prescription for getting too spooked by this. They have contin- levels would be above the Fed’s stated
and keeping inflation under control, uously declared that these supply-side goal of 2% inflation. However, underLABOR PAINS
Employment dropped precipitously during the onset of the COVID-19 pandemic
1997 Total: 1,060
66%
64%
U.S. Employment to Population Ratio
62%
60%
58%
56%
54%
52%
50%
21
07
09
11
13
17
19
71
73
75
77
81
83
85
87
15
79
89
91
93
95
99
01
03
05
97
20
20
20
20
20
20
20
19
19
19
19
19
19
19
19
20
19
19
19
19
19
19
20
20
20
19
SOURCE: U.S. BUREAU OF LABOR STATISTICS
FIGURE 1
the Fed’s new policy framework of Normally, the Fed’s response would be pre-pandemic. The economy is indeed
“average inflation targeting,” the cen- to raise interest rates, tightening mon- reopening and of the more than 22 mil-
tral bank will allow inflation to run etary policy and slowing the economy lion jobs lost in the immediate aftermath
above 2% for some time to help offset to get inflation under control. However, of the great lockdown, 17 million have
those earlier periods we have wit- that model relies on the idea that excess been regained. Yet that still leaves the
nessed during which inflation had been demand is causing inflation – more economy 5 million jobs shy of where it
under its target. goods and services being consumed had been. The unemployment rate, at
At BNY Mellon, we have been arguing than the economy can produce when 5.2%, remains well above the pre-pan-
for quite a while that inflation was going it is at full employment of its resources, demic low of 3.5%.
to be higher and longer lasting than labor force, and technological capabil- Furthermore, the employment-
the Fed’s sanguine view had asserted. ities. As we have described above, cur- to-population ratio, a measure of how
COVID-19 represents a global shock rent inflation is primarily supply-side many people in the country are working,
impacting everything from shipping driven. What the recipe is to rein in is at 58.5% (see Figure 1), a level last seen
and materials prices to the availability price increases in such an environment, in the aftermath of the Global Financial
of semiconductors and natural gas. is still up for debate, but it certainly Crisis and before that, in the early 1980s.
In addition, multi-decade-long forces doesn’t include the loose monetary Not coincidentally, the latter period
of global disinflation, including the policy setting on which the economy is corresponded to a recession engi-
internationalization of production and currently running. neered at the end the 1970s, when the
supply chains, off-shore manufacturing, On the other side is, of course, the Fed raised interest rates to extraor-
and just-in-time logistics, are beginning labor market. Total employment in the dinarily high levels to combat high
to retreat. economy remains far below levels seen and persistent inflation. By 1982,PURSE STRINGS
Median household income was rising steadily, until the pandemic
66,000
64,000
62,000
Real Median Household Income
60,000
55,000
50,000
45,000
40,000
68
70
72
74
78
80
82
84
76
86
88
90
92
96
98
02
04
06
08
94
00
10
12
14
16
20
18
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
20
20
20
20
19
20
20
20
20
20
20
20
SOURCE: U.S. CENSUS BUREAU
FIGURE 2
unemployment had reached 10.7%. inflation now comes as America is only “A DANGEROUS MAN”
Powell has placed a great deal of slowly getting back to work. In addition to the economic tradeoffs
importance not just on getting the This is the essence of the Fed’s policy between inflation and employment,
labor market back to full employment, dilemma: Inflation is above its target the Fed is navigating politically fraught
which he says is “a long way off,” but and the labor market is not fully healed waters. How to craft policy to address
also making sure that future employment (see Figure 3). Powell himself recently the inflation-employment tradeoff, with
gains are well distributed across demo- bemoaned this situation: “This is not the the composition of the Fed’s leadership
graphic, gender, and income groups. situation that we have faced for a very likely to change, both on the Board of
This requires keeping monetary policy long time and it is one in which there is Governors as well as the wider Federal
loose, possibly at the expense of higher a tension between our two objectives.” Open Market Committee (FOMC), is an
inflation. The pandemic has disrupted Congress, the Fed’s overseer, is now open question.
the labor market and it may take years involving itself in the policy debate. For Powell’s term as chair expires on
to match unemployed workers with jobs. example, Senator Joe Manchin (D-WV) February 5, 2022. His renomination by
We wrote about this “reallocation shock” has circulated a memo in which he President Biden and confirmation by
during the pandemic. requires the Fed to “end quantitative the Senate is not a foregone conclusion.
Long-running economic forces have easing” as one of the conditions for him And the terms of two other key mem-
kept a lid on real earnings for decades to vote for President Biden’s “soft infra- bers of the Board of Governors are set
now. Only around five years ago did structure” package. This is a challenge to expire. Vice Chair Richard Clarida’s
median real household income in the to the Fed’s statutory independence in term expires in September of next year,
U.S. begin to rise (see Figure 2). Higher conducting monetary policy. while Vice Chair for Supervision Randy“Dramatic changes in personnel at the top of the central bank—as well as among the Board of Governors—could upset markets, especially if continuity in monetary policy looks likely to be threatened.” Quarles’s term expires this year on portfolio includes supervision) as too – despite key progressive opposition October 13. In addition, there is a still- lax in its approach and overly solici- like Warren’s – is another attraction. vacant governor’s position that needs tous of large banks’ preferences, par- Bloomberg has reported that Treasury to be filled. ticularly in relation to crafting stress Secretary Janet Yellen, the Fed Chair This is a high degree of potential turn- tests, supervising and implementing preceding Powell, is supportive of his over and an opportunity for President capital requirements, and supervising renomination. Does Biden heed the Biden to reshape the Board’s makeup. commercial lending. powerful Senator Warren, or his top The politics of nominating and con- If Biden were to renominate Powell, economic policymaker Yellen? firming each of these positions are he would likely have bipartisan support Other potential nominees who daunting, and in the current environ- for confirmation on both sides of the could wind up being nominated if ment, quite delicate. aisle in the Senate, although several key Powell were not to go forward include Key members of Congress and others senators are thought likely to oppose current Governor Lael Brainard, the have pushed for more gender and racial him. In particular, at a recent hearing only Democrat on the Board. She was diversity, both on the Board itself and of the Senate Banking Committee, considered by Biden for the Treasury within the broader Federal Reserve Senator Elizabeth Warren (D-MA), Secretary role, which ultimately System, including the leadership of called him a “dangerous man” and went to Yellen. She has served on the regional Federal Reserve banks. declared her opposition to a potential the Board since 2014, was nominated Furthermore, five of the six current gov- second Powell term. Committee Chair by Obama, and previously worked ernors are registered Republicans, four Sherrod Brown (D-OH) has not made his in key posts in the executive branch of whom were appointed by former views on a Powell renomination known, under Obama (Under Secretary for President Donald Trump. Powell, a nor used such incendiary language, but International Affairs), as well as under Republican, was first appointed to has explicitly voiced his objection to President Clinton in various advisory the Board in 2012 by then-President Quarles, going as far as to say that “he roles in the White House. A potential Barack Obama and elevated to Chair should not be there after October.” Brainard nomination could be a very in 2017 by Trump. By many accounts, it is thought that close vote in the full Senate, with most In addition to the diversity issue, President Biden would like to renomi- Republicans likely to oppose. banking supervision is a major source nate Powell, striving for continuity in Raphael Bostic, the current pres- of concern. Progressives in Congress such a key economic policy position at ident of the Atlanta Fed, is another regard the current Fed, and in par- a delicate point in the economic cycle. potential nominee to the Board. He is ticular Vice Chair Quarles (whose Powell’s broad bipartisan support widely respected for his leadership of
COST CENTER
Prices are creeping higher, but we are not reaching an inflation scare
16%
14%
Consumer Price Index
Inflation, year over year (%)
12%
Personal Consumption Expenditure
10%
8%
6%
4%
2%
0%
-2%
07
09
11
13
17
19
21
71
73
75
77
81
83
85
87
15
79
89
91
93
95
99
01
03
05
97
20
20
20
20
20
20
20
19
19
19
19
19
19
19
19
20
19
19
19
19
19
19
20
20
20
19
SOURCES: U.S. BUREAU OF LABOR STATISTICS, U.S. CENSUS BUREAU
FIGURE 3
the regional Fed bank and his views personal securities transactions they A DELICATE TENSION
on monetary policy are well-regarded made during the pandemic, which With the Fed caught in a monetary
among mainstream economists. He although compliant with ethics rules policy dilemma, as well as confronting
is also the only African American and in each bank, have come to be seen wide-ranging leadership changes –
openly gay member of the Federal Open as black marks on the Federal Reserve even if Powell gets renominated and
Market Committee. Another potential System’s public standing. confirmed - markets will have a lot to
pick if Biden were to go in another R e g i o n a l Fe d p r e s i d e n t s a r e contemplate. For example, the presi-
direction would be Roger Ferguson, appointed by the Board of Directors of dent of the Boston Fed, whenever the
a former vice chair of the Fed, who is each bank, subject to the approval of the person is placed in that position, will
most recently on the Board of Directors Board of Governors in Washington, D.C. be replacing a fairly hawkish member
of Alphabet, the parent company There is no presidential or congressional in Rosengren.
of Google. involvement in the appointments, but The FOMC rotates voting members
In addition to the Chair and three with the scrutiny that Rosengren and every year among the regional Fed
other Board of Governors’ positions Kaplan have come under, as well as the presidents, and Boston becomes a
(see Figure 4), two vacancies in the Fed's recent congressional and public voting bank in 2022. Will the new pres-
regional Fed banks have suddenly perception issues, these appointments ident stay true to Rosengren’s hawkish
become open. Eric Rosengren (former will be equally delicate – key members leanings or bring a much more dovish
president of the Boston Fed) and Robert of C ongress have extolled the perspective to the committee? If Powell
Kaplan (former president of the Dallas need for diverse leadership at the is replaced by Brainard, we think the
Fed) have come under criticism for regional Feds as well. FOMC could take an overall dovishFOLLOW THE LEADER
The current makeup of the Fed's board of governors has several officials’ terms
expiring around the same time
RANDY QUARLES JEROME POWELL RICHARD CLARIDA
Vice-Chair for Supervision Chair Vice-Chair
OCTOBER 13, 2021 * FEBRUARY 5, 2022 * SEPTEMBER 17, 2022 *
JANUARY 31, 2024 JANUARY 31, 2026 JANUARY 31, 2030 JANUARY 31, 2034
CHRISTOPHER MICHELLE
VACANT LAEL BRAINARD WALLER BOWMAN
Governor Governor Governor Governor
FIGURE 4 *Clarida's term as Governor ends on January 31, 2022
Powell's term as Governor ends on January 31, 2028
Quarles's term as Governor ends on January 31, 2032
turn, meaning it could be less inclined congressional scrutiny to not run upset markets, especially if continuity
to tighten monetary policy in favor afoul of its overseers. Independence in monetary policy looks likely to be
of letting the economy run “hot” to enshrined by Congress can be eroded threatened. Higher inflation that per-
address the labor market slack. by Congress, and the Fed as an institu- sists could usher in a world of higher
Overall, the Fed risks becoming tion has been strategic in staying on the borrowing costs, while a slowing
much more politicized, caught between right side of the legislature. economy could menace the economy.
competing interests in Congress, and On monetary policy, however, the Either outcome would probably sub-
President Biden’s ability to reshape realities of the post-pandemic economy ject the Fed to even more scrutiny from
the board, all subject to senatorial con- have crystalized the inflation-employ- Congress and/or the executive branch.
firmation. We have written about the ment tradeoff to a high degree. How This too would roil the markets as the
threats to central banks’ independence the Fed tries to run an optimal policy Fed’s credibility and independence
around the world and remind readers in the face of high inflation and a weak could be further weakened.
that former President Trump put enor- labor market will be a challenge to
mous public pressure on Chair Powell financial markets as well as the real
before the pandemic to maintain economy and the citizenry that forms John Velis is an FX and macro strategist
easy money policies. the Fed’s constituency. at BNY Mellon Americas.
The Fed’s independence has been Dramatic changes in personnel at Questions or comments? Write to
granted by Congress, and throughout the top of the central bank – as well as John.Velis@bnymellon.com or reach out
the years, it has had to navigate among the Board of Governors – could to your usual relationship manager.BNYMELLON.COM
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