Why is the Squad attacking Jerome Powell?
Is this actually about the stance of monetary policy?
The Squad is on the warpath against Jerome Powell. Alexandria Ocasio-Cortez, Rashida Tlaib, Ayana Pressley, and and a couple other progressives in Congress released a statement urging Biden not to nominate Powell for a second term. Here are some excerpts from the Politico article that originally reported the statement:
[The representatives] acknowledged that the Fed under Powell “has made positive changes” by steering the central bank toward a greater emphasis on reaching full employment. But they said they want to see someone at the helm who is more aggressive on financial regulation and climate change.
“Under his leadership, the Federal Reserve has taken very little action to mitigate the risk climate change poses to our financial system,” said [the letter.]
“At a time when the Intergovernmental Panel on Climate Change is warning of the potential catastrophic and irreversible damage inflicted by a changing climate, we need a leader at the helm that will take bold and decisive action to eliminate climate risk,” they said.
They also cited moves by the Fed under Powell to reduce regulations on big banks, such as giving them more leeway to make risky trades and more advance information about tests that examine if they could withstand another major economic downturn.
“Weakening financial regulations that were specifically created to prevent such a disaster from happening again risks the livelihoods of Americans across the country,” the lawmakers said. “To move forward with a whole of government approach that eliminates climate risk while making our financial system safer, we need a Chair who is committed to these objectives.”
Few Democratic lawmakers have actively opposed Powell, although Sens. Sherrod Brown of Ohio and Elizabeth Warren of Massachusetts are among those who have also criticized his deregulatory efforts over the past few years.
It’s possible — given that these are American politicians — that this is some kind of play for media attention from legislators who have been out of the news for a bit. Or it could be a tactical move, to give Biden cover to reappoint Powell while looking like a centrist. It’s also possible that these are good-faith criticisms and that we should think about them seriously. It’s also possible that this is actually about a brewing fight over the country’s approach to monetary policy. This latter possibility is where things would really get interesting.
But first let’s think about the criticisms the Squad is leveling at Powell.
Climate risk and financial deregulation
The Squad’s first beef with the Fed Chair is that he’s not trying to eliminate climate risk. Powell has stated definitively that the Fed doesn’t take climate change into account when setting monetary policy. Of course climate change is very important, and so perhaps it’s natural for people to get mad about a top government official saying he’s not going to personally try to do anything about it. But the fact is that the Fed simply has very little to do with regards to climate change.
The Fed’s primary function is to balance inflation and unemployment, by setting interest rates and doing other financial market manipulation like quantitative easing and such. Essentially, if the Fed thinks too many people are out of a job and we need to speed up growth so that they get jobs, they pump money into the economy, and if they think prices are rising too fast they take money out of the economy. Yes, it’s more complicated than that, but not much more complicated.
So how does this interact with the climate? Well, if you’re a degrowther, then you think faster growth is bad for climate change, and you might generally want hard-money policies to slow things down (even at the inevitable cost of jobs). But if you’re a green-growther, maybe you might think that a hotter-running economy would stimulate investment in things like solar electricity. So you might want easy-money policies to speed growth.
But then you’d also have to think that the private sector will do the right thing with those dollars — that they’ll invest in solar and wind and energy storage rather than new natural gas plants and gas-consuming factories. Since AOC’s Green New Deal is based on the idea of government taking over the reins of climate-related investment from the private sector, it’s a safe bet that the Squad does not think that simply handing cheap money to businesses will direct investment in the right direction.
So it’s not at all clear whether easier or harder money would be useful for fighting climate change. What about more specific policies? ECB President Christine Lagarde has suggested directing corporate bond purchases to companies that are better on climate. But the Fed almost never buys corporate bonds (it did buy a little bit during 2020 as an emergency measure), and if it did want to direct its purchases toward greener companies, that would almost certainly require an act of Congress. The same goes for making loans to companies, as the Fed did in order to combat Covid.
The Fed’s job is to ensure low unemployment and price stability; if you want to change that, change the law that defines what the Fed’s job is. If you can’t do that, you have a problem. And even if you do change the law, it’s doubtful that a central bank can do much in this regard anyway.
How about financial deregulation? Here, the critics have more of a case. Powell supported a 2018 bill to remove regulations for banks with between $50 billion and $250 billion in assets. It’s not clear what economic purpose is served by deregulating these mid-size banks. Capital is already insanely cheap in the U.S. economy, and it’s not clear what mid-size banks could add if only they were freed from the yoke of regulation. The “might as well deregulate” approach to finance failed in the 90s and 00s, and history has shown that big banks aren’t the only ones with the capability to cause havoc in the financial system.
What’s more, Powell has gone easy on banks in a number of other ways, reducing the Liquidity Coverage Ratio at a time when many sensible voices are calling for increased capital requirements. And he weakened the requirement for banks to submit resolution plans regarding the possibility of future bankruptcy. Again, with interest rates and credit spreads both at record lows it’s not clear why these measures are needed.
Perhaps Powell does have a reason for these, of course. It might be that he thinks that systematically going easier on mid-size banks will discourage banks from merging and becoming too large. Or he might think that mid-size banks provide an important function in evaluating the quality of borrowers, and that they thus deserve a break from regulators so that they can reduce the number of bad loans in the system. It’s hard to know; this stuff can get complicated. And Powell’s critics don’t really seem to have a good handle on what kind of principles they’d like to see applied to finreg — Max Moran, writing at The American Prospect, attacks Powell both for encouraging bank mergers and for systematically penalizing larger banks with stricter regulations than those applying to smaller banks. There is almost certainly a better guiding principle here than “anything banks want is bad”.
So while I do think Powell has gone a bit too easy on the banks, I doubt it’s as big a deal as his critics on the Left allege. If that’s enough for you to want to fire him, fine, but it wouldn’t be enough for me, especially given the stellar job he’s done with respect to the pandemic.
Is this really about the stance of monetary policy?
So while there are a few criticisms to be made of Powell, overall it seems pretty overblown — not the kind of thing worth spending political capital on or making a big deal out of. But there’s the possibility that the criticisms over climate and finreg are actually a cover for a deeper issue: A desire to implement much easier monetary policy in a systematic way.
The Squad didn’t go into this explicitly. But some of the people on the Left from whom they’re probably drawing their ideas seem to want a major, durable shift toward a more accommodative monetary stance than what Powell might deliver. Here’s Moran again:
Last August, Powell approved a stealthy sabotage of future efforts to prioritize employment in a non-pandemic scenario when the Fed updated its monetary policy framework statement…
Powell’s reinvention as America’s foremost dove is also new, and potentially transitory. In 2017, Bloomberg considered him the second-most hawkish of the Fed’s six permanent voting members, and about median among all the governors. They placed him down the middle in 2015 as well. His dovish turn is welcome, of course, but it shouldn’t be considered deeply held or durable, should the political winds shift.
AOC, meanwhile, has been favorable toward MMT, a theory whose actual views on the workings of the economy are not very coherent, but whose adherents’ policy recommendation is pretty consistently to pump up deficit spending and finance that spending with easy money (though they wouldn’t put it in those terms).
Powell has been strongly dovish throughout the Covid pandemic, unleashing massive quantitative easing and finding creative ways to shovel money to businesses. But now, in the face of persistently above-target inflation, he’s talking about tapering QE. This is probably what most mainstream economists would recommend as the proper way to bring inflation back down to target. But if you want to shift monetary policy to a permanently easier stance — either because you think boosting employment simply matters much much more than curbing inflation, or because you want to keep money cheap to help the government borrow and spend — then this standard Fed balancing act is not your cup of tea.
But shifting the stance of monetary policy in a dovish direction comes with risks. According to the “regime change” theory of inflation, the tradeoff between unemployment and inflation can change radically and abruptly. When people believe that the Fed won’t let inflation get high, the Fed can pump out a ton of easy money without spurring actual sustained or significant inflation. But when people think the Fed has basically stopped caring about inflation and just wants to pump out easy money — possibly to boost employment, but usually to facilitate government borrowing — then you get all of the costs of easy money with none of the usual benefits.
Thus, any attempt to push the Fed toward a permanently easier stance is risky. And what’s even more risky is for politicians to attack Fed independence by pushing to hire a Fed Chair who will turn on the taps and leave them open. Trump started down this road when he tried to intimidate the Fed into leaving rates low in order to help his reelection bid. But if the Left started doing this too, the danger to the Fed’s hard-won independence will be all the greater.
If the Squad is indeed trying to push a shift toward easier monetary policy, then it’s very good of them to couch their attempt in the language of climate change and financial regulation. An explicit, Trump-like attack on central bank independence would be worse — even though the anti-Powell movement is highly likely to fizzle. But if permanently easier money is indeed what the Left wants, we should realize that, and think very carefully about the dangers involved.
Tyler Cowen just recommended Scott Sumner's new book on market monetarism. Can we get a future post about your take on that philosophy?
Think you miss an important part of the policy demands here: forcing climate risk considerations into financial stability tests enables climate policy by government.
John Cochrane has had a couple of posts on how ridiculous it is for climate change considerations to be part of financial stability concerns. And on physical risk, he's probably right, on any time horizon that current policymakers should be concerned with. But he's very wrong on transition risk.
Transition risk is policy that makes formerly profitable businesses bust. The Fed forcing banks to conduct climate stress tests will mean that businesses exposed to transition risk will not get loans. So monetary policy authorities implement some climate policy in this way. And it also means the banks don't go bust when transition risk is realised. Which makes climate policy by the government easier to implement (as they won't be killing the financial sector when they do so).
So I understand entirely the Squad's insistence that climate change be part of the Fed's remit.