With President Donald Trump naming Jerome H. Powell as his nominee for chair of the Federal Reserve on Thursday, many are expecting a continuation of the interest rate and monetary policy established by outgoing chair Janet Yellen. Although Powell is a Republican, he has stuck solidly with Yellen’s policies ever since the Obama administration appointed him as a Fed governor in 2012.
Powell’s nomination was seen as a “safe gamble” by Trump, but he may turn out to be less dovish on monetary policy and easier on bank regulation than Yellen has been, according to Wharton experts.
“We can expect, largely speaking, to have continuity on the path that we’ve seen with Yellen, with perhaps at the margin some Powell-specific leanings or tendencies,” said Wharton finance professor Krista Schwarz. She agreed with many analysts that it seemed like Trump did not want to rock the boat with his choice for the next Fed chair. “His interest is to have low rates and an easy policy going forward.” Schwarz added that it might have been politically difficult for Trump to reappoint Yellen. “Powell was a more palatable choice on that front.” Trump criticized Yellen during the 2016 presidential campaign for keeping interest rates too low to help the Obama administration look good; but later, as president, he has praised her as well.
The Yellen Fed has held a steady pace with increasing the federal funds rate in doses of 0.25%, starting with a December 2015 increase that ended a seven-year run of near zero rates. This was followed by increases in December 2016, and in March and June 2017. However, Yellen has pushed for a more rapid shrinkage of the $4.2 trillion worth of securities the Fed mopped up during the 2008 financial crisis by allowing them to mature. Powell has supported that approach, but financial regulation is an area where one might see some changes.
Among the many sticking points between Democrats and Republicans has been the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act the Obama administration pushed through as a response to the financial crisis. Although there has been bipartisan criticism of Dodd-Frank, Republicans led by Trump have said the act regulates banks too tightly and want it repealed. While the recession led to pressure on banks to boost their capital to absorb future shocks, many finanicial institutions view the benchmark Basel III capital requirements as far too stringent. Even Dodd-Frank’s strongest supporters acknowledge that parts of the law could be tweaked to remove excessive financial regulation and made simpler, but the worry is that much of what is good in it will be undone.
“Powell is not an ideologue and he has not been beating any ‘Repeal Dodd-Frank’ drum, which has been the mantra of the House Republicans,” said Peter Conti-Brown, Wharton professor of legal studies and business ethics. “That said, his supervision of the implementation of capital requirements under Basel III would look different from that of Janet Yellen.” The Basel Committee on Banking Supervision, named for its headquarters in Basel, Switzerland, sets the regulatory framework for banks globally on capital adequacy, stress testing and liquidity.
“Powell has said we have probably gone too far and we need a lighter touch and to let banks set their own parameters to some extent on how much debt they are willing to take on,” said Conti-Brown. He noted that Powell has also called for “a lighter touch” in the supervision over the implementation of those rules. “So it is going to be a change, but not a wholesale abandonment of the Dodd-Frank model.”
“We can expect to have continuity on the path that we’ve seen with Yellen with perhaps at the margin some Powell-specific leanings or tendencies.”–Krista Schwarz
Schwarz and Conti-Brown discussed the likely course of monetary policy under a Powell Fed on the Knowledge at Wharton show on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.)
One way observers have tried to predict how Powell might lead the Fed is to understand what Trump wants. “Ultimately, Mr. Trump, who as a real estate developer benefited from cheap credit, came down for Mr. Powell, whom he hopes will deliver lower interest rates,” a New York Times report said after Powell’s nomination. “Our view is Powell is the GOP version of Yellen, with the added kicker of wanting to reduce regulation,” said Tom Porcelli, chief United States economist at RBC Capital Markets in the same report.
That said, Powell’s choice was not obvious, and not just because he is not trained as an economist unlike previous Fed chairs, and has been a lawyer and banker by trade. “There is so much that is unusual about this process, and not the least is Jerome Powell himself,” said Conti-Brown, the author of a book on the Fed. Five years ago, Fed watchers would not have named Powell as one among 50 or even a 100 candidates for the Fed chair’s role, he added. Powell is a Barack Obama appointee, not an economist, and “not a monetary policy guru prior to his time on the Fed board,” while he has in the last five years participated actively “within the Janet Yellen consensus,” he noted. “To the extent that there is daylight between a Powell Fed and a Yellen Fed, we haven’t seen it.”
“We have a creaky, old payments system. Governor Powell has real expertise on what is needed in the U.S. to modernize the payments system.”–Peter Conti-Brown
Added Schwarz: “[Powell] certainly followed the consensus brought about by Janet Yellen. That is not to say he did not have his own thoughts and ideas and bring those to the table as well.”
A Hawkish Tinge on Interest Rates?
While the financial markets reportedly expect an interest rate hike in December this year and two increases next year, “we have no idea” what course a Powell Fed will take, said Conti-Brown. “The sense is that Powell and Yellen don’t disagree on this moderately hawkish view — that we should be raising interest rates.” Powell did not show his cards when Trump announced his nomination at the White House yesterday. He only said, “I will continue to work with my colleagues to ensure that the Federal Reserve remains vigilant and prepared to respond to changes in markets and evolving risks,” as The New York Times reported.
“Powell has a tendency to be more aggressive than Yellen would have been otherwise,” said Schwarz. “That said, I agree with Peter that we are in an uncertain place. It’s not clear even to the most experts in monetary policy [as to] what’s going on with inflation, what the outlook is and how that is relating to other asset price: Is there a bubble forming? Are we at risk for a quick upshot in inflation?” she added. “All else equal, Powell relative to Yellen would argue that there is the risk of a big spike-up in inflation at some point.”
Schwarz noted that while Yellen has adopted a policy of not raising rates too quickly, “Powell, if anything would tilt somewhat towards being hawkish relative to Yellen. He would be more likely to follow a more rapid pace of tightening — not right away — and this is very much at the margin.”
“There is so much that is unusual about this process, and not the least is Jerome Powell himself.”–Peter Conti-Brown
In any event, Powell’s style is unlike that of previous Fed chairs like Alan Greenspan or Paul Volcker, where “it was always the chairman that went first, and then everybody [else on the Fed board] would fall in line,” Schwarz noted. “After all, these are consensus decisions,” she said, adding that Yellen has fostered that committee approach and debate.
Conti-Brown agreed with Schwarz. “Nothing about [Powell’s] history suggests that he wants to stand on ceremony, be the Fed prima donna, barking orders. If he tried, he would fail, and I’m sure that is something he is mindful of — precedents have been set by failed Fed chairs.”
Expertise in Regulation and Supervision
According to Conti-Brown, one area where Powell could make a real difference is in upgrading and digitizing the U.S. payments and settlements system, noting that it is his primary area of expertise. “We lag by every major indicator in the way that people settle transactions as opposed to other developed economies,” he said. “Anytime that you are paying for something — writing a check, using a credit card, or using your phone — we settle a huge number of transactions, but we do it worse than people do it even in parts of Africa. We have a creaky, old payments system. The very fact that we are still writing paper checks strikes people as Neanderthal. Governor Powell has real expertise on what is needed in the U.S. to modernize the payments system.”
Conti-Brown said the reluctance to create new payments systems has been because of security concerns, as new systems bring new vulnerabilities. “The march towards digitizing the payments system in an analog world is fraught with cyber security perils.” Here, he said “it would be interesting to watch how Powell works with Randal Quarles,” who was last month appointed Fed vice chairman for supervision, a new role created after the 2008 financial crisis, but left unfilled until now.
The Demise of a Tradition
Conti-Brown noted that Trump departed from tradition by not reappointing Yellen for a second term when her current one expires on February 3, 2018. “There has also been a long tradition of cross-partisan reappointment from Democrats to Republicans where a sitting president has always given a second term to the sitting Fed chair, no matter which the original sponsoring party was,” he said. “We’ve lost that and that is something to lament. And I think it’s very hard to get it back.” Incidentally, Yellen will continue to serve a 14-year term as a Fed board member that ends on January 31, 2024.
It would be counterproductive for any U.S. president to try to get a yes-person as the Fed chair. “An infringement on the Fed’s independence would be a very bad outcome,” Schwarz said in a recent Knowledge at Wharton article. “Credibility is crucial to anchoring inflation expectations and guiding investment and savings decisions in the economy.”
“There is a 50:50 likelihood that in the next four years we will have a recession. That is something that Powell will be facing.”–Krista Schwarz
With Yellen’s term as Fed chair drawing to a close, Schwarz and Conti-Brown took stock of her performance. “Her legacy perhaps would be the way she has handled the take-off of rates back to ‘normalization’ of policy and she initiated the roll-off of the Fed’s very, very large balance sheet,” said Schwarz. Yellen gave “a direction” to the process of downsizing the Fed’s holding of securities it bought during and after the financial crisis.
Conti-Brown praised Yellen for her “courage in taking bold action,” adding that she has performed “remarkably well” in managing the transition towards normalization.
Yellen’s legacy could also include the sustained period of growth after the financial crisis, said Schwarz. However, that could change during Powell’s tenure, she noted. “There is a 50:50 likelihood that in the next four years we will have a recession. That is something that Powell will be facing.”