It would be difficult to overestimate the importance of the Federal Reserve Board. While it cannot always boost the economy as much as it would like when the country falls into a recession, the Fed’s ability to raise interest rates gives it the power to impede economic growth and to keep millions of people from getting jobs.
It has repeatedly used this power in the last half-century, slowing growth and in some cases bringing on recessions. In each case, it has justified its decision to slow the economy through concerns about inflation. The argument has been that inflation risks getting out of control if the Fed allows the labor market to get too tight.
The story was that if too many people have jobs, then workers will have more bargaining power, and be able to get larger pay increases. These higher pay increases would get passed on in higher prices, which would lead workers to demand still higher wages, and we suddenly have a wage-price spiral like in the 1970s.
As Federal Reserve chair, Jerome Powell has broken sharply with this fixation on inflation. He has listened to the complaints that progressive Fed critics have been making for decades.
We have said that inflation is not always just around the corner. And when the Fed raises rates, it disproportionately hits those who are most disadvantaged in the labor market: Blacks, Hispanics, the disabled, workers with less education, and people with criminal records. We argued that the Fed needs to take seriously its legal commitment to full employment, not just its commitment to price stability.
Powell has explicitly embraced this logic. He has committed the Fed to keeping its key federal funds rate at zero until the economy approaches full employment. He sees the latter as being in the range of the 3.5 percent rate that we were seeing before the pandemic, not the 5.0 to 5.5 percent rates considered a floor by many economists just a few years ago.
Getting the unemployment rate down to levels like 3.5 percent, and possibly lower, is important not only to the millions of workers who are thereby allowed to get jobs. It also gives tens of millions of workers the bargaining power and security to achieve wage gains and get their share of the benefits of economic growth. The only sustained periods in the last four decades in which real wages rose for typical workers were the low-unemployment years in the late 1990s, and the five years leading up to the pandemic. Low unemployment is the main factor determining most workers’ sense of economic well-being.
This matters not only for the economy but also for politics. When a president runs for re-election with a strong economy, they always win. On the other hand, if the unemployment rate is high and the economy is weak, as was the case in 1992 with the first Bush and in 2020 with Donald Trump, they can lose. (Barack Obama in 2012 was a notable exception, but only barely.) This is why the need for reappointing Powell goes beyond the enormous economic case.
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Some have argued that Biden can find someone else to be Fed chair who would be as good in pushing full employment and better on regulatory issues. The most obvious person who could fit this bill is Lael Brainard, who has been a member of the Fed’s Board of Governors since 2014. While Brainard would likely be an outstanding Fed chair, there are two big problems with going this route.
First, we can assume that Republicans would do everything possible to block her approval. It is likely that there will be 50 Senate votes against, which means if any of the centrist Dems gets cute, Biden doesn’t have a Fed chair. By contrast, almost every Republican voted for Powell as Fed chair less than four years ago. There are few limits to Republicans’ shamelessness, but it might be hard for many to explain how the person they embraced enthusiastically four years ago is not qualified now.
The other issue is that incumbency bestows enormous authority, both inside the Fed, where the chair must pull the rest of the Fed’s Open Market Committee along in supporting their policy, and in the larger policy community. Length of tenure, not great wisdom, was the basis of the enormous authority granted to Alan Greenspan’s comments on everything from trade and taxes to Social Security.
We don’t need ancient history to see what happens to a Fed chair who isn’t perceived as having great authority. Jimmy Carter was forced to remove G. William Miller, his pick as Fed chair, a year and a half after he was appointed. He replaced him with Paul Volcker, who threw the economy into a recession in 1980, guaranteeing that Carter would not be re-elected.
We can’t afford to take this sort of risk again under President Biden. We need to keep the steady hand we have now at the Fed, as the economy will definitely go through some rough times reopening from the pandemic.
Incumbency bestows enormous authority, both inside the Fed and in the larger policy community.
Some progressives have claimed that we have already won the battle for full employment. Having fought this one, along with many great allies, for more than a quarter-century, I would love to believe this is true. Unfortunately, you would have to ignore just about everything being said by economists and policy types about Biden’s agenda to believe that the war is over.
The idea that the Fed’s responsibility is first and foremost to stem inflation runs deep in the economics profession. In fact, our current treasury secretary, Janet Yellen, had three preemptive rate hikes when she was Fed chair before Powell. If the inflation hawks have somehow surrendered, I missed the ceremony, and they are not acting like a defeated army.
As far as financial regulation, it is important, as I have often said. But it is orders of magnitude less important than maintaining full employment. There is a myth about the cause of the Great Recession, that it was about the financial crisis, and not the collapse of the housing bubble. This myth was useful to Wall Street because it was their rationale for bailing out Citigroup, Goldman, and other behemoths who would have been sunk if we allowed the market to work its magic.
The claim was that the bank bailout was necessary to avoid a second Great Depression. I have often challenged proponents of this view, and in response have never gotten more than vigorous hand-waving, name-calling, and an occasional obscenity. The bailout prevented a once-in-a-century opportunity to eliminate a huge amount of bloat in the financial sector in one fell swoop.
We do need to have strong regulation of the industry, for reasons I have written about many times. Toward this end, it would be great to have a solid appointee as vice chair for regulation, like former Fed governor and deputy treasury secretary Sarah Bloom Raskin, when the position comes open in September.
People have raised other complaints against Powell, like he has not been stronger on climate change. There may be a legal case that the Fed can act to penalize lenders to the fossil fuel industry, but as a practical matter, Congress has not explicitly granted it that authority.
There may also be a legal case that the Army could seize U.S. oil fields and cease their operation as part of its national-security mission, but if it were to do so, we could probably count in minutes the time it would take Congress to strip that authority. The same is true for the Fed.
In short, we have a Fed chair in Jerome Powell who has openly embraced full employment, one of the most important items on progressives’ agenda for many decades. It is hard to imagine that we would not want to keep him there.