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The Journal Gazette

Monday, November 06, 2017 1:00 am

'A vote for continuity'

But non-economist leading Fed is also risky

Scott Sumner

Scott Sumner is an emeritus professor of economics at Bentley University and director of the Program on Monetary Policy at the Mercatus Center. He wrote this for the Washington Post.

President Donald Trump's appointment of Jerome Powell to chair the Federal Reserve can be seen as a vote for continuity, as Powell is widely expected to maintain the policy approach of current Fed Chair Janet Yellen. In many ways that's a good thing.

Recent Fed policy has produced stable growth and low inflation, which is all we can really ask from monetary policy. Powell is also well-liked and respected within the Fed and will probably be able to work effectively with his colleagues.

Nonetheless, there are a few reasons to be concerned about his appointment. The past four Fed chairs have all been economists, with a deep understanding of monetary policy. Powell is a lawyer. Putting a lawyer in charge of the Fed is roughly analogous to naming an economist to be chief justice of the Supreme Court.

That's not to say it can't work. Both positions have lots of extremely qualified staff assisting them, and Powell has already had some on-the-job training during his period on the Federal Reserve Board. But there are lots of more qualified people available, including Yellen. It's not clear why a change is being made, especially given that Yellen's performance has been excellent by the usual metrics.

Some might object to the Supreme Court analogy by arguing that being Fed chair simply involves raising and lowering interest rates to keep the economy stable. In this view, low interest rates represent an “easy money policy.” But there's much more to monetary policy than adjusting interest rates, which is why we should want a highly qualified specialist at the central bank.

Even many economists can get confused by the connection between interest rates and monetary policy, but the problem is even more severe among non-economists. Consider this recent comment by Powell: “In contrast, the (Federal Open Market Committee's) easing of monetary policy increased over time as the longer-term economic effects of the crisis gradually became clear. From 2007 through 2013, the FOMC added ever greater support for the economy.”

At first glance, that looks plausible. The federal funds rate – that is, the interest rate targeted by the Fed that banks charge each other for loans – fell from 5.25 percent in July 2007 to 2 percent in May 2008. Non-economists might see this as a policy by the Fed of easy money. But in fact, policy was getting much tighter during that time. Rates did not fall because of anything the Fed did; indeed, the Fed did not inject any new money into the economy over that 10-month period. Rather rates fell because the economy was weakening rapidly during the financial crisis. The Fed failed to cut its interest rate target fast enough to reflect this weakness, and hence we tipped into recession.

The last non-economist to serve as Fed chair was William Miller. His performance during the Carter administration was so poor that he was replaced after 17 months. Interestingly, his problems were quite similar to what we experienced during the financial crisis, but in the opposite direction. Miller thought that to fight the high inflation of the time it was enough to keep interest rates high. But rates were high because of inflation. His replacement, Paul Volcker, had a much deeper understanding of monetary economics. He understood that the Fed needed to tighten the money supply to get inflation under control, even if that meant temporarily ignoring interest rates.

Another concern is that Powell believes the Fed should focus not just on macroeconomic stability, but should also try to prevent financial market excesses. As he said earlier this year: “I would also agree that monetary policy may sometimes face tradeoffs between macroeconomic objectives and financial stability.”

Many economists are skeptical of this view – for good reason. In 1929, the Fed tightened policy to try to stop a stock market bubble, tipping the economy into the Great Depression. In the long run, a stable macroeconomic environment is most conducive to a stable financial system. Financial excesses are better addressed through regulation, not the blunt instrument of monetary policy.

Despite these reservations, I expect Powell to do fine in the near future. He is a consensus decision-maker in the mold of Ben Bernanke and Yellen, not a more dictatorial type like Alan Greenspan and Volcker. Over the next few years, he is likely to continue Yellen's policy approach.

The real danger occurs at the extremes of high inflation or a deep recession. It's at those times that a deep understanding of monetary policy is most essential. A job as important as Fed chair should be given only to the most highly qualified individuals.