Fed Chair Jerome Powell has spent his day in a nomination hearing before the Senate Banking Committee, which has to decide whether to ratify President Biden's recommendation to grant him a second four-year term in the job. The process allows Powell to set out his version of his accomplishments to date, as well as allowing Senators an opportunity to pick holes in his record. Despite some strong criticism, largely from the Republican side, confirmation is all but certain.
Powell's opening statement understandably focuses on the unprecedented challenges the Fed has faced as a result of the COVID pandemic. He credits both the Fed's actions and those of Congress with making the impact of the pandemic much less severe than it could have been, and with setting a strong recovery in train:
"The initial contraction was the fastest and deepest on record, but the pain could have been much worse.
Congress provided by far the fastest and largest response to any postwar economic downturn. At the Federal Reserve, we used the full range of policy tools at our disposal. We moved quickly to restore vital flows of credit to households, communities, and businesses and to stabilize the financial system.
These collective policy actions, the development and availability of vaccines, and American resilience worked in concert, first to cushion the pandemic's economic blows and then to spark a historically strong recovery."
Looking ahead, Powell emphasizes both the Fed's commitment to its inflation target and its pursuit of a stable financial system:
"We know that high inflation exacts a toll, particularly for those less able to meet the higher costs of essentials like food, housing, and transportation. We are strongly committed to achieving our statutory goals of maximum employment and price stability. We will use our tools to support the economy and a strong labor market and to prevent higher inflation from becoming entrenched.....
Over the past four years, my colleagues and I have continued the work of our predecessors to ensure a strong and resilient financial system. We increased capital and liquidity requirements for the largest banks—and currently, capital and liquidity levels at our largest, most systemically important banks are at multidecade highs......
We also updated our monetary policy framework, drawing on insights from people and communities across the country, to reflect the challenges of conducting policy in an era of persistently low interest rates."
Unsurprisingly, Senators used the question period to ask why the Fed got its inflation call so wrong. Powell's response, as reported by CNN:
“..... we believed based on our analysis and discussions with people in industry that the supply side issues would be alleviated more quickly than now appears to be the case,” Powell said. “Substantially more quickly.”
The Fed chief added that officials expected a “much more significant return to the workforce than has turned out to be the case. ....While that is not what is causing current inflation,” Powell said, “labor supply can be an issue going forward for inflation, probably more than the supply side issues.”
Powell said supply side challenges have been “more persistent and more substantial” than expected.
Looking ahead, Powell said his expectation is there will be “some relief” on the supply front this year and global supply chains “will loosen up.” If that doesn’t happen and inflation proves to be “even more persistent and higher,” Powell said that would increase the risk of it “becoming entrenched in the psychology” of businesses and households. “That would indicate that we would respond,” he added.
In terms of policy in the coming months, Powell was forthright concerning the Fed's willingness to act. As regards the taper of quantitative easing, he described the Fed's $ 9 trillion balance sheet as "far above where it needs to be" and said that the process of shrinking would be "sooner and faster. That much is clear". This is consistent with the last two post-FOMC statements.
In terms of rate hikes, Powell's stance was unmistakably hawkish. Quoting again from the CNN version:
“If we have to raise interest rates more over time, we will .....We will use our tools to get inflation back.”
“To get the kind of very strong labor market we want with high participation, it is going to take a long expansion. We can see participation is only moving very slowly. And to get a long expansion, we will need price stability.”
“In a way, high inflation is a severe threat to the achievement of maximum employment and to achieving a long expansion that could give us that.”
Market expectations for what this means in practical terms have been steadily hardening, with Jamie Dimon at Goldman Sachs apparently convinced that there will be as much as 200 bp of tightening by the end of the year. With so much uncertainty over the impact of the omicron variant, that still seems improbable, but one thing that is certain is the Fed's intentions will face an early test. December CPI data are due tomorrow (January 12), and are widely expected to show a further sharp uptick in core CPI to well above 5 percent, the highest reading in decades. You sure you want another four years in the job, Jay?
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