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Powell's legacy tested by inflation, bank crisis, new Fed dynamics

2023-05-16 18:16
By Howard Schneider WASHINGTON Federal Reserve Chair Jerome Powell, who navigated a combative White House and a pandemic
Powell's legacy tested by inflation, bank crisis, new Fed dynamics

By Howard Schneider

WASHINGTON Federal Reserve Chair Jerome Powell, who navigated a combative White House and a pandemic in his first years as head of the U.S. central bank, is facing a critical chapter in his leadership with a battle against inflation still unresolved, worries about recession widespread, and developing criticism of the Fed's oversight of the financial industry.

On one level, President Joe Biden's nomination last week of a relatively new member of the Fed's board of governors to become vice chair of the central bank seems a vote of confidence in Powell, who was elevated to the top job by former President Donald Trump, given a second term by Biden, and is now a senior figure with more than a decade-long tenure at the Fed.

Yet it also poses a test of the 70-year-old central banker's stewardship as he faces difficult decisions about the direction of interest rates, the lowest public approval ratings of any recent Fed chief, and an unusual call from within for an external review of Fed supervision.

It's a period that will shape whether Powell is remembered as the Fed leader who tamed inflation without a recession and kept a stressed financial system intact, or as the one who lost control of prices and resorted to punishing rate hikes to regain it.

"Powell and his colleagues are currently in a policy space with enormous implications for 2024," as they try to curb inflation without causing a recession and increased unemployment heading into a presidential election, said Peter Conti-Brown, a Fed historian and associate professor at the University of Pennsylvania's Wharton School.

The mood towards the central bank among U.S. lawmakers will be tested this week when Fed Vice Chair for Supervision Michael Barr appears before congressional committees on Tuesday and Thursday. The Fed's inspector general faces a separate hearing on Wednesday on "Strengthening accountability at the Federal Reserve." Powell will give remarks at a Fed conference on Friday.

LOW RATINGS

The public opinion of Powell, meanwhile, appears to have soured.

When he took over the Fed in 2018 he pledged a plain-spoken approach and made changes that tried to elevate the interests of workers. A Wall Street lawyer and private equity executive for much of his career, Powell routinely opens press conferences bysaying he wants Fed policies "that benefit all."

Following the worst inflation surge in 40 years, the skyrocketing rate hikes that followed, and a string of high-profile bank failures, a recent Gallup poll found confidence in Powell at the lowest mark of any Fed chief since the question was first asked in 2001.

There have been bipartisan calls for tougher outside oversight of the Fed, and mounting across-the-board criticism: that it was Powell's acquiescence to deregulation during the Trump administration that allowed bank problems to fester or that he is now likely to react in a way that hurts smaller banks; that he hasn't raised rates enough to control inflation or that he has already gone too far and put the economy at risk.

Some of that criticism has come from inside the Fed, unusual for an institution that works through consensus and guards its independence.

Fed Governor Michelle Bowman on Friday called a recent Fed review of Silicon Valley Bank's failure "limited," and argued the central bank needed "an independent third party ... to fully understand" why the Santa Clara, California-based bank collapsed.

Fed historians said the call by a sitting policymaker for an outside review was rare if not unprecedented, and suggests the debate over bank supervision could be lengthy.

"An external review would certainly prolong and potentially complicate the Fed's next steps in addressing its regulatory and supervisory performance," said Sarah Binder, a Fed historian and professor at George Washington University in the U.S. capital.

INFLATION MISDIAGNOSIS

Powell arguably secured his second term with a do-anything-it-takes handling of the COVID-19 pandemic that sped the recovery and supercharged the impact of federal fiscal stimulus as Biden took office in 2021.

But the initial misdiagnosis that same year of rising inflation as being "transitory" forced a rapid series of rate increases whose effects on the economy and labor market are still building.

Inflation is slowing, but remains high. After revising Fed strategy to project jobs, policymakers - and Powell - now say they will accept higher unemployment if that's a consequence of returning inflation to the Fed's 2% target.

In deciding the next policy steps, Powell will have a new second-in-command if the U.S. Senate confirms Biden's recent nomination of Fed Governor Philip Jefferson as vice chair.

Jefferson would help steer a policy debate that could become particularly pointed as the Fed begins a meeting-by-meeting, data-focused set of decisions on whether to raise rates further or hold them steady. The risk on one side is that high inflation becomes embedded, on the other of a deeper-than-needed economic downturn.

'WIDEN YOUR LENS'

Jefferson, who has a PhD in economics and worked briefly at the Fed in the 1990s, joined its board a year ago after a career in teaching and college administration.

His appointment is a departure from recent vice chairs who have been drawn from among top central bankers and included people with long track records at the Fed, like Janet Yellen, who led the central bank from 2014 to 2018 and is currently head of the Treasury Department, or were steeped in monetary policy, like Stanley Fischer, a mentor to many global officials.

But the choice allowed Biden to solve a separate political problem by leaving a seat open for the nomination of labor economist Adriana Kugler as the first Latina member of the Fed board.

After a relatively soft-spoken first year, Jefferson has few "strongly articulated priors on monetary policy" to judge his approach, Krishna Guha, vice chairman at Evercore ISI and a former New York Fed official, wrote last week.

But Jefferson on Friday showed what is perhaps the key attribute for a vice chair. In a previously scheduled address on the day of his nomination, he made a pointed defense of where the Powell-led Fed stands during a conference typically stacked with critics of the U.S. central bank at Stanford University's Hoover Institution.

Anyone arguing the Fed is not "on track," Jefferson said, should be "willing to widen your lens" and consider how much the economy might have shifted during the pandemic.

(Reporting by Howard Schneider; Additional reporting by Ann Saphir; Editing by Dan Burns and Paul Simao)