For years the talking heads and their guests on cable news endlessly chattered about interest rates remaining near zero in the US and negative in Europe. They talked of the “new normal”. However, some complained that interest rates had remained too low for too long and of the importance of raising interest rates and reducing the Fed balance sheet so that the Fed would have powder to fight a downturn in the economy. Upon his becoming Fed chairman, Jerome Powell quickly demonstrated that he believed in the latter approach. We were in un-chartered territory. Never before had interest rates been so low for as long or had QE been used to such an extent. There was talk about a neutral rate of interest. They hadn’t learned that just as every reduction in interest rates or expansion of the Fed balance sheet had spurred the economy, every raise in interest rates or reduction in the balance sheet negatively impacts the economy. The interest rate and size of the Fed balance sheet you are at at any given time can be considered neutral because any increase in the rate of interest or sale of Fed assets slows the economy and any decrease in the rate or purchase of assets stimulates the economy.
Although the economy was growing and there was no sign of inflation when he was appointed, Chairman Powell chose not to wait patiently. He began his chairmanship by raising interest rates and reducing the Fed’s bond portfolio much too quickly. He did so at a time when the growing economy and rising corporate profits were beginning to generate additional federal tax revenues which would have reduced the federal deficit. As predictable his actions negatively impacted the economy and the stock market which went into a steep decline. His final 1/4 point raise of interest rates in December of 2018 while the stock market was collapsing was not just stupid, it was idiotic. To make matters worse he recklessly announced plans for further rate increases and balance sheet reductions in 2019. His actions were instrumental in killing the momentum that the corporate tax cuts (a once in a generation stimulus) had generated in the US economy and raised a serious likelihood of causing a downturn in the US economy. Corporations that were already spooked by President Trump’s attempt to level the playing field in trade by imposing tariffs, immediately began to reconsider and postpone capital investments.
After being strongly criticized by President Trump and many others he quickly reversed course, He announced that further rate increases would be delayed and introduced the concept of “patience”. This word selection demonstrated that he either still didn’t fully understand his prior mistakes or that he wouldn’t acknowledge them because he wanted to show he was independent and wouldn’t bow to President Trump’s wishes. What he obviously meant by “patience” was that he would delay further increases. He didn’t recognize that rates were already too high and that the December increase should have been reversed. However, cancelling intended further rate increases did stimulate the stock market and permitted economic expansion to continue. Recently when corporate earnings came under pressure and the stock market went into a tailspin again based in large part on trade and border issues and a lack of infrastructure spending, he took notice of the market decline and the possibility of a coming recession by talking about potential interest rate cuts this year. Although he slowed Fed asset asset sales he did not discontinue them to the chagrin of President Trump.
Chairman Powell appears to be learning on the job. I ask if he has learned too little, too late. At the June meeting of the Fed he recognized that the Fed can take preventive steps to extend economic growth and avoid a recession rather than waiting to reverse one. He also recognized that governmental actions relating to trade and Congressional failures to act should be taken into consideration by the Fed. But, he should have acknowledged his prior errors and reduced interest rates. Although we can expect a rate decrease in July, I fear he still does not appreciate the desirability of low interest rates for an indeterminate period or of growing the economy at a rate in excess of 2% a year and will be more concerned with appearing to be independent. Instead of worrying about his independence, he should be coordinating with administration officials to be better able to coordinate Fed policies with fiscal policy. The Fed’s independence is assured by statute. Its actions do not need approval of the President or Congress. Its role in ending the Great Recession was important to our prosperity. However, when it makes serious mistakes it should welcome criticism from the President and others. Whether or not he can be replaced as Chairman by the President, when the Fed chairman makes repeated errors he should resign.
Since he has spent his time thinking about interest rates and the Fed balance sheet, it seems unlikely that he now recognizes or has even thought about the risk that market factors which might cause a stock market collapse present a similar risk to the US economy as existed in the 1930’s. As I have written recently he could have worked with the SEC and taken steps to reduce stock market manipulation and volatility and the risk of a stock market collapse which might follow or lead to a serious recession or even a depression. The overheating of IPO offerings in recent weeks has been fueled by increased margin borrowing on both the long and short sides of transactions.
He has recently talked of living with inflation even if exceeds the 2% guideline of the Fed. However I expect that he would probably panic and choke off the economy if it accelerated again (as it could if we spent trillions of dollars on needed infrastructure for highways, bridges, airports or security, or if we spent to limit the effects of climate change by upgrading levees and dams to control flooding or built an interstate fresh water pipeline (the most important project of this century) and began to grow our economy at 4, 5, or 6 %. I expect he would fear inflation even though the causes of inflation were absent. Robots are coming and they will make employees available for non-inflationary economic growth thereby enhancing the Amazon related deflationary effects on the economy. China builds new cities. Why can’t we upgrade ours instead of letting widespread crime turn them into slums? Of course we would have to deal with the limits of available raw materials and the socialist jerks who would argue that the rich are getting richer even if we were creating millions of high paying jobs for a large number of currently low income workers and generating tax revenues to enable us to pay for for the greatest welfare state the world has ever known.
The Fed’s role is important. Unless our economy grows at a satisfactory pace, the rising number of politicians chanting for socialism may in a short time lead to the end of the great American capitalism experiment.