Powell’s finest hour

Powell’s Volcker moment

Volcker faced a much tougher economic backdrop than Powell. The “Misery index—the sum of inflation and the unemployment rate—was almost three times higher (Chart). The Fed’s anti-inflation credibility was deeply damaged by Volcker’s predecessors. The University of Michigan measure of long-run inflation peaked at 9.7% in 1981 and did not drop below 4% until ten years later; today it moved briefly above 4%. Under Volcker it took the dual recessions of 1980 and 1981-2 to reverse inflation. Today, absent the trade war, the Fed seemed to be getting inflation back to target without triggering an outright recession. 

Not surprisingly, given how miserable the economy was, Volcker faced some of the strongest political attacks and most widespread protests in Fed history.  These included indebted farmers using tractors to blockade the Eccles Building and homebuilders mailing the Fed pieces of 2x4 lumber in protest. Both members of Congress and Administration officials heaped pressure on Volcker.

However, Presidential pressure on Powell is much higher than for Volcker. No President has come close to Trump’s highly personalize, public criticism the Fed Chair. Reagan did pressure the Fed to not to tighten policy before the 1984 election, but this was done in private (and Volcker wasn’t planning to tighten anyway). Reagan left the aggressive attacks to members of his Administration. He also did not threaten to fire Volcker. Indeed, Volcker had been a Carter appointment, but Reagan reappointed him anyway in 1983. 

The Powell Fed is already dovish

The irony in all of this is that while Powell is being attacked for being too hawkish, a better critique of the Powell Fed is that it has been a bit too dovish. From my perch on Wall Steet and now in blogland, I have written a series of modestly critical pieces. Most important, I’ve argued:

·       the 2020 framework change created a dovish bias for the Fed, testing the limits of full employment and leaning heavily on a “structurally” flat and stable Phillips curve.

·       The “inclusive” goal for the labor market conflicted with the Fed’s inflation goal—the Fed can’t both target an unemployment rate consistent with its inflation target and target a unemployment rate that gives extra benefits to disadvantaged workers.

·       The economy did not need so much stimulus coming out of COVID, with huge fiscal packages and an aggressively easy Fed. The US stimulus was much bigger than for other advanced economies.

·       The Fed was too slow to respond to rising inflation in 2021 as the unemployment rate rapidly dropped toward full employment (about 4%) and core measures of inflation like the trimmed mean repeatedly registered very high month-over-month annualized readings (Chart).

·       Even today, the FOMC is more dovish than I am in three respects: (1) they seem to be ruling out any chance of rate hikes (2) their estimates of the neutral policy rate are too low—they are at 3% and I am at 4%, and there are two dovish dissenters. 

Just to be clear, these critiques in no way justify recent attempts to fire Powell. These are honest differences of opinion during a challenging time for gauging the outlook. Moreover, Powell has had plenty of support from the economic consensus in these dovish episodes. Most important, when push comes to shove, he has made two courageous hawkish choices. First, recognizing that the Fed was behind the curve in 2022, the Powell Fed risked a recession with one of the fastest hiking cycles in history (Chart). Second, he has strongly defended Fed independence, focusing on fundamentals, not taking the bait in personal attacks and refusing to step down. These two strategic choices easily offset any tactical errors. 

I have not yet begun to fight

One final thought. Some argue that it would be in the institution’s best interest for Powell to step aside. I think this is a terrible idea. Trump’s attacks on Powell may sound very personal, but Powell’s only “crime” has been doing his job. The attack is on the Independence of the Fed and Powell simply stands in the way of that effort. If Powell steps aside that would encourage more attacks, shifting them onto the rest of the Committee that just voted 9-2 to remain on hold.

Powell staying on also provides cover for the rest of the Committee in a very challenging time for deciding on appropriate policy. He sets an example for the Committee as it faces many battles ahead. Trump can replace two technocrats—Powell and Kugler—next year, but the rest of the Committee will (I certainly hope) set policy based on economic fundamentals.