Joe Biden’s Jerome Powell decision

Within the next few months, President Biden will need to make a very important economic decision. He will need to decide whether or not to offer Jerome Powell a second term as the head of the Federal Reserve when his first term expires next February.

The importance of this decision can be illustrated by an apocryphal story about the legendary Paul Volcker, the former Fed chairman who slayed inflation in the early 1980s by his aggressive interest rate policy. When asked by a journalist how it felt to be the second most important person in the land, Volcker supposedly asked who was the most important person.

There are compelling arguments both in favor and against offering Powell a second term.

One argument in favor of reappointing Powell is to reward him for the strong leadership and foresight he displayed in responding to the COVID-19 crisis. By acting boldly with his unprecedentedly aggressive bond-buying program, Powell almost surely spared the country from a painful and prolonged economic depression in the pandemic’s wake.

Another argument in favor of keeping Powell on the job is that he is turning out to be a very dovish Fed chair. Under his leadership, the Fed has agreed to tolerate, at least temporarily, higher inflation than its 2 percent inflation target. It has also agreed not to raise interest rates or taper its aggressive bond-buying program until it sees actual signs that inflation is permanently rising. These policies are helping both to fuel a very rapid economic recovery and to keep a powerful equity and housing bull market going. Could any president ask more from the Fed chair? 

Yet another reason for making an early announcement that Powell will stay on the job is to assure markets that there will be policy continuity and that the Fed appointment is not politically motivated. By keeping a well-respected Trump appointee in place, markets might take comfort that the Fed will not be politicized. This could be particularly important at a time when Biden’s administration is engaged in the largest peacetime budget stimulus on record and when inflation expectations are at risk of becoming unanchored.

Against these arguments is the strong likelihood that Powell has made a fundamental policy miscalculation as to the inflationary forces that are now building in the economy. That miscalculation has led him to continue too long with the Fed’s ultra-low interest rate policy and with maintaining the current $120 billion monthly pace of Treasury bonds and mortgage-backed security buying.

Month after month, inflation has been rising and is now running at its highest pace in the past 30 years, underlining the possibility of a long-lasting inflationary burst. This has forced the Fed to acknowledge that inflation this year will be well above its earlier expectations and will exceed the Fed’s 2 percent inflation target by a wide margin.

Moreover, the Fed is keeping its foot on the monetary policy pedal at the very time that the country is experiencing its largest peacetime budget stimulus on record and as an enormous amount of pent-up demand was built up during the pandemic’s lockdown phase. This could soon lead to economic overheating. 

The key risk for Biden in making an early renomination announcement is that he would be taking ownership of the Powell Fed’s policies. This would be all well and good, if today’s high inflation turns out to be the transitory phenomenon that Powell claims it to be. But in the event that inflation turns out to be more permanent, an early renomination could be politically costly for Biden in the run up to next year’s important midterm elections. This would be particularly the case if the Fed were forced to soon slam on the monetary policy brakes in order to keep inflation in check since that could cause today’s equity and housing market bubbles to burst. 

Biden’s politically prudent course of action would be to wait a few months and see how inflation plays out. But judging by Treasury Secretary Janet Yellen’s recent praise of Powell’s stewardship at the Fed, it would seem very likely that Biden will make an early renomination announcement. This makes it all too likely that Biden will act in haste with an early announcement only to repent later when the U.S. economy has a hard landing next year and when he will no longer be in a position to blame the Powell Fed.   

Desmond Lachman is a senior fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.