President Joe Biden has announced he would nominate current Federal Reserve Chair, Jerome Powell, for a second four-year term. announcement comes after months of speculation and indecision as the Biden administration resisted calls from other factions of the Democratic Party to remove Powell.
With Powell likely to be confirmed he now faces the unenviable task of navigating the current inflationary surge and quelling any possibility of inflation spiraling out of control.
Earlier this month the Bureau of Labor Statistics (BLS) reported that inflation hit 6.2 percent over the last 12 months, the largest annual increase in over 30 years.
This surge in inflation is, at least in part, driven by the pandemic. With supply chain disruptions and the current global economic recovery brewing the perfect storm for global inflation. In the United States, the largest movers in inflation have been areas directly affected by these forces with energy prices, and used car and truck prices, increasing 30 percent and 26.4 percent over the past 12 months.
But despite higher energy prices and supply bottlenecks being a global phenomenon, U.S. inflation is higher than almost all other developed countries. This points to domestic conditions also playing a role. In particular, the Federal Reserve aggressively expanded its balance sheet from the onset of the pandemic and this has been amplified by an unprecedented fiscal expansion, first started by President Trump’s stimulus checks and continued by Biden’s American Rescue Plan. total fiscal expansion has meant that the combined fiscal deficits from 2020 and 2021 have totaled close to $6 trillion (or 27 percent of GDP).
re is now a growing chorus of economists concerned that the current surge in inflation will become persistent. Most prominently, former U.S. Treasury Secretary, Larry Summers sounded the alarm of potential inflation early and has now pointed the finger squarely at U.S. domestic policy.
“If you put too much water in the bathtub, it starts to overflow,” Summers warned in March.
How Will the Fed Contain Inflation?
Federal Reserve now must decide how to wind back its aggressive monetary expansion. re is no doubt it has the tools to fight inflation, but how it does it without stalling the economy is the key question. Tighten too quickly and it risks halting the economic recovery. Tighten too slowly and it risks inflation getting away from it.
Fed has already started to change tact. Acknowledging the growing threat of inflation earlier this month the Federal Reserve Board decided to pare back its purchases of Treasuries by $10 billion per month. But despite the economic recovery, policy still remains very accommodative with real interest rates still currently around -1 percent.
Whether the tapering will be enough to tame inflation and generate a “soft landing” is an open question. Market indicators are currently giving some mixed signals. Market inflation expectations believe inflation will average 3 percent over the next 5 years (the Federal Reserve targets 2 percent average inflation). But longer-term expectations continue to show faith in the Federal Reserve with the 5-year, 5-year forward inflation expectations (which measures the average inflation over 5 years starting 5 years from now) is still tracking just above 2 percent.
Powell and the Future Federal Reserve
Outside of inflation, Jerome Powell will also need to navigate some more existential questions facing the Federal Reserve. This comes as Powell’s reappointment, though expected, was not guaranteed. A faction of the Democrats favored removing Powell due to the perception of him being soft on banking regulation and climate change.
Sen. Elizabeth Warren (D-Mass.) earlier this year called Powell a “dangerous man” to chair the Federal Reserve, arguing that winding back of some banking regulation has destabilized the U.S. banking system.
It is reported that progressives advocated for Lael Brainard, who was appointed as vice-Chair of the Fed. Despite Powell and Brainard having broadly similar views on monetary policy, Brainard’s views on other facets of the Federal Reserve differ from Powells. For example, Brainard has dissented to the winding back of financial regulation, has emphasized the need to consider climate change when stress-testing banks, and wants the Fed to develop its own digital currency.
Powell’s next 4 years as Fed Chair will be critical in determining the direction and role of the central bank in these highly political and ever-changing areas.
Pezou : Challenges Facing the Federal Reserve