© Bloomberg. WASHINGTON, DC – JUNE
(Bloomberg) – Federal Reserve Chairman Jerome Powell does not hide his admiration for Alan Greenspan. And now, more than halfway through Powell’s four-year tenure, his Fed looks a lot like the man once dubbed the Monetary Maestro.
It is a Fed which, as statements made at the institution’s virtual symposium made clear last month, prioritizes flexibility in setting monetary policy as it grapples with a pandemic that devastated the economy. There will be no hard and fast rules for when to raise interest rates and when to reduce them.
Ahead of a policy-making meeting next week, stealth – a hallmark of Greenspan’s time at the helm of the Fed – is once again in vogue as officials pursue ultra-expansionary policies to reduce unemployment and push through unemployment. inflation temporarily above its 2% target.
Unlike his immediate predecessors – Janet Yellen and Ben Bernanke – Powell is not an economic Brainiac with a doctorate from a prestigious university. A lawyer who made his fortune in private equity, the politically savvy Powell prides himself on his clear speech, not his familiarity with complex business models that spew out precise policy prescriptions.
“Bernanke and Yellen wanted to make monetary policy scientific,” said Mellon’s chief economist Vincent Reinhart. “Powell wants to build the Fed constituency with the public and American politicians and do so by turning away from the image of central bankers in white coats.”
Even the most theoretically rigorous economists would probably agree that the Fed needs to be nimble to tackle the coronavirus crisis, given the uncertain outlook. Economic models built on past relationships have limited value in analyzing a disaster that occurs once in a century.
The disadvantages of discretion
But discretion has its drawbacks. It’s harder for the Fed to convince consumers and businesses that it is serious about hitting its new 2% average inflation target without a clear commitment to do so. This is a concern, given the importance of the role that expectations play in the inflation process: if people think prices are going up, they are acting to get there.
A flexible Fed may also be more sensitive to political pressures to keep interest rates low for too long – pressure that could intensify as public debt soars. During Powell’s first two years in office, President Donald Trump often harangued the Fed for keeping rates too high – to no apparent effect. A future chair might not be so firm.
Another danger of Powell’s ultra-expansionary policy: sparkling asset markets. This is a danger familiar to Greenspan. His largely successful 20-year career in managing the economy was marred by the collapse of the Nasdaq stock market in 2001 and his tolerance for a real estate bubble that burst after his departure from the Fed. in 2006.
The revamped strategy commits the central bank to achieving a maximum employment target which, for the first time, is described as “broad and inclusive”. This is especially timely given the disproportionate impact the pandemic has on the lives and livelihoods of blacks and other minorities – and the pressure on the Fed to do something.
The change was welcomed by Democrats and Republicans.
Rep. Emanuel Cleaver, a Democrat from Missouri who chairs the House Financial Services Committee’s monetary policy panel, said he was “personally satisfied” with the move, while committee-ranking Republican Patrick McHenry of Caroline of the North, called the strategy a “good thing for the American. worker.”
Policymakers also reinterpreted their 2% inflation target, saying they were aiming for this outcome over time and were prepared to temporarily accept price increases above that, without specifying by how much or for how long.
“We don’t stick to a particular mathematical formula that defines the mean,” Powell said at the Fed’s annual conference in Jackson Hole on Aug. 27. “Our decisions on an appropriate monetary policy will continue to reflect a wide range of considerations.”
Former Fed official Peter Hooper called the stance a “Greenspanian.”
Powell “hesitates a little to be locked up”, the German Bank (DE 🙂 said the global head of economic research.
At a Brookings Institution virtual conference on September 1, Bernanke attempted to argue that the Fed’s new master plan is not that different from the more specific policy prescriptions proposed by himself and others. In the end, however, he had to admit that the guiding document “is not very explicit”.
Asked to rate the Fed’s effort, the former university professor gave it an “incomplete” rating, saying he expects it to unveil more precise guidance on its rate plans soon. ‘interest.
Fed officials do not seem in a rush to do so. “I’d rather wait,” Dallas Fed Chairman Robert Kaplan told Bloomberg Television on Aug. 28. “I would prefer to have more clarity on the trajectory of the virus.
Greenspan has never publicly adopted a numerical inflation target. Instead, he said the Fed would know it had achieved price stability when households and businesses no longer factor in inflation.
It wasn’t until 2012 that the Bernanke-led Fed adopted a 2% inflation target in its very first long-term strategy statement.
“When they released the statement in 2012, the impetus was to set it in stone,” Reinhart said. “The new version is much more situational. It’s not for the ages. “
The latest document highlights the Fed’s dilemma today – a structurally low interest rate environment – and promises a thorough review of the strategy five years from now.
“The whole framework is aimed at trying to preserve stability in a complex economic system rather than performing a bivariate optimization exercise in an economic model,” said Lou Crandall, chief economist at Wrightson ICAP (LON :).
There are fewer trained economists among Fed policymakers than there were in 2012, he said.
The Fed’s review included 13 research papers authored by economists on everything from the impact of targeting average inflation on the well-being of blacks to the fallout it could have in financial markets. This led PGIM Fixed Income’s chief economist, Nathan Sheets, to suggest that the new strategy is “a merger of Greenspan with Bernanke and Yellen. It is rooted in sophisticated cutting-edge thinking in the economics profession, but it also relies heavily on discretion. “
In his first address to the Fed’s policy conference in Jackson Hole, Wyoming, in 2018, Powell highlighted the uncertainties surrounding economic concepts such as the natural rate of unemployment and praised Greenspan for allowing unemployment to fall below of this level seen in the late 1990s.
The Powell framework goes even further. Instead of avoiding pushing unemployment below its natural rate, the Fed is now prepared to allow unemployment to fall even further until inflation shows signs of rising too rapidly.
Rules versus discretion
There is a long-standing debate in the economics profession about how best to conduct policy – through rules or discretion. Proponents of the rules argue that a more predictable policy is superior because it allows businesses and consumers to better plan for their future. Advocates of discretion argue that central bankers need leeway to react to changes in the economy.
Ultimately, however, Powell recognizes that the success of his new approach depends on actions, not words.
“What we do in the future is really going to decide how effective the changes we make are,” he said at the Jackson Hole virtual conference last month. “Time will tell and our actions will tell it in the end.”
© 2020 Bloomberg L.P.