Jay Powell’s problem

I attended a presentation by the Chair of the Federal Reserve Jay Powell in Atlanta in early January 2019. This was part of the annual meeting of the American Economics' Association. This year that meeting was held in Atlanta. The presentation took the form of an interview conducted by the Economic Correspondent of the New York Times, Neil Irwin. The interview was with the current Chair of the Federal Reserve and the two previous Chairs, Janet Yellen and Ben Bernanke.

The lead up to this presentation was more than interesting. The stockmarket had fallen heavily between mid-September and the end of December. In the December meeting of the Fed, the Fed had downgraded its estimate of growth in 2019 from 2.5% to 2.3%. On the day before the presentation, the President of the Dallas Fed Robert Kaplan had announced that the Dallas Fed thought that US growth in 2019 would be only 1.8%. This made sense in a State like Texas where low oil prices would generate lower levels of investment and slow national economic growth.

In previous weeks, a widely read article in the Wall Street Journal by former Fed Reserve member, Kevin Warsh, had argued that the Fed was tightening too severely by increasing interest rates at the same time as selling down the holdings of bonds to reduce the size of the Federal Reserve balance sheet.

I was lucky enough to get a seat in the front row. I was no more than five meters from any of the speakers. Sitting on my left was the long term Chief Economist of the IMF, Olivier Blanchard, who this year was the outgoing President of the American Economics' Association. On my right was the economic correspondent of the Washington Post.

A reason for pause

Jay Powell opened with a commentary about current conditions in the US economy. Reading from his prepared notes, he said that the current conditions reminded him of 2016 when he first came to the Federal Reserve Board. At that time, Janet Yellen was Chair. He said that uncertainty at that time led the Fed to pause its increases in interest rates.

I well remembered 2016. The Fed did not just pause interest rates for a quarter. The Fed paused interest rates for a whole year. I was amazed to see monetary policy being made right in front of me. I imagined the very positive effect his statements would have on the market. I was right. The Dow was up 600 points within two hours of my leaving the room.

Over the next hour, some serious matters were discussed, some not so serious. Almost immediately after Jay Powell had concluded his initial comments. Neil Irwin asked him whether he had an appointment with the President. Powell said no. Irwin asked him would he resign if the President asked him to. Powell said no. The room then erupted into laughter.

Back to serious matters, the three Fed Chairs discussed the response of inflation to falling unemployment. Powell said that in the current cycle, US inflation had been far less responsive to declines in unemployment than was previously the case. I became impressed at how well previous heads of the Fed had been consulted. Both Janet Yellen and Ben Bernanke then both joined in a discussion or the lack of responsiveness of US inflation to the current very low levels of unemployment. Powell commented that US unemployment was the lowest since 1968 and 1969.

Fed Unready

One matter of concern was the reduction in the ability of the Federal Reserve to deal with future financial crises. Powell, Yellen and Bernanke all expressed concern that many of the facilities which were used to support major financial corporations in the financial crisis have now been taken away from the Federal Reserve.

Congress undertook this action to remove what it regarded as "moral hazard". The political view is that if these facilities were not available, then banks would not get themselves into so much trouble. The problem is that most financial crises happen for completely unexpected reasons. When the next one happens in the US, the Federal Reserve will be much less able to deal with the crisis than it was on the previous occasion.

Jay Powell's Problem

As I watched Jay Powell through his presentation, I was impressed how concerned he was to avoid the next US recession.

His reference to 2016 was interesting. At that time the economy was growing reasonably well. There was, however, a significant deterioration in the market for corporate debt. At that time and again now, investment growth corporate bond yields were rising relative to treasury yields. This signalled a reduction in liquidity necessary for corporate investment. This caused the US economy to slow.