The Federal Reserve (the “Fed”) has a major impact on the economy. Its monetary policies affect employment, inflation, interest rates, and economic growth. It has the power, by making a policy mistake, can tip the economy into recession. (The Fed also has important regulatory responsibilities, but that’s not an issue right now.)
The Fed decides how much money is in circulation, and sets short-term interest rates. It determines bank reserve requirements.
For over a decade now, the Fed’s stimulative monetary policies have inflated stock and home prices, and by keeping interest rates low, have rewarded borrowers and shortchanged savers. All of this was intentional. Stocks were inflated to encourage consumers to spend more, and interest rates were kept low to stimulate the economy, prevent borrower defaults, make borrowing cheaper for the government and businesses, and combat deflationary pressures in the economy following the worst recession since the 1930s.
The most important Fed policies are decided by a 12-member committee (i.e., the Federal Open Market Committee, or “FOMC,” details here), which is headed by a “chair,” currently Jerome Powell (bio here). His 4-year term expires on February 5, 2022, and President Biden soon will decide whether to reappoint him, or replace hime with someone else (story here).
Powell was appointed to his present position by Trump, and is a Republican, but was first appointed to the Federal Reserve Board by Obama and has considerable bipartisan support. He’s won praise for the Fed’s response to the Covid-19 pandemic, and isn’t viewed as a partisan hack in Washington D.C.’s power circles. Wikipedia describes him as “a consensus-builder and problem-solver,” and says, “Powell tolerates high inflation, high asset prices, and strongly disfavors deflation.”
And there’s the rub. Those policies benefit some people, but hurt others, especially retirees on fixed incomes or dependent on investments for retirement income. Inflated stock values make investors richer on paper, but also make buying stocks dangerous, because stock buyers could lose a lot of money if stock prices ever come back down to normal (i.e., market-determined) prices.
The most controversial feature Fed policy under Powell is letting inflation run “hot.” If you have money in the bank earning 1% interest, and inflation is 6%, your savings are losing 5% of their purchasing power every year. This is de facto confiscation, and you’re subsidizing people with a lot of debt. This is what economists call “moral hazard,” i.e., rewarding “bad” behavior (borrowing and promiscuous spending) at the expense of “good” behaviors (saving and thrift).
This, too, is intentional — which makes it all the worse. We now have a credit-driven economy, in which growth depends on people borrowing to make purchases, and saving is intentionally discouraged because saved money isn’t spent on goods and services, and it’s spending that creates jobs.
But, as I said, inflation coupled with punishing saving hurts retirees. An inflationary monetary policy also hurts low-wage workers, who are less likely to get raises, and more likely to fall behind in an inflationary economy.
To be blunt, the Fed is manipulating the economy. Free-market advocates don’t like that. They see it as government interference. Worse, it creates market distortions. (Their argument is true, but whether the government should interfere with markets is a philosophical question. I would say yes, to a point, within limits. The long history of market excesses and market crashes suggests a totally libertarian approach to market regulation invites disaster.) Some people don’t like the Fed at all and think it should be abolished. (I don’t agree with them.)
Monetary policy, and economics in general, is highly complex. There aren’t pat answers, and can’t be. While math is used in the decision-making process, the results of a policy decision aren’t mathematically calculable, because you’re dealing with human behavior, which isn’t always rational and isn’t reducible to mathematical equations. There’s always guesswork involved.
Moreover, the data used to make policy decisions are often incomplete and always imperfect. Thus, manipulating the economy, which is what the Fed does, is prone to miscalculation, error, and unexpected results. That’s why some people wish the Fed would keep its hands off the economy entirely. (I disagree, but I’m in favor of nudging, not oversteering.)
Whatever decision Biden makes is more likely to align with his political interests than your personal advantage. Presidents who want to get re-elected, or help their party in midterm elections, want a booming economy, which often means juicing the economy, even at the expense of a recession later. Biden is no different. Powell’s “easy money” policies play into his hands.
The current inflation surge isn’t entirely the Fed’s fault, although some of it is. The Fed has pumped a lot of money into the economy, mostly through the financial system, which is why it affects stocks and bonds first. But this inflation bump also is partly due to pandemic-induced disruptions and shortages; Powell insists these price increases are temporary, and some of them are, but with employers raising wages to attract scarce workers, some of them will stick.
This inflation also is party due to what the Fed isn’t doing. It isn’t raising interest rates, which is how you strangle inflation. You can’t have both low interest rates and low inflation; you have to choose. It’s a matter of what your priorities are.
Fed policies aren’t primarily responsible for soaring home prices; a nationwide housing shortage is. The 2007 housing crash stifled residential construction for several years, but population kept growing, so now we have a housing shortage. Simple as that. But by keeping mortgage rates low, the Fed’s policies increase demand for what housing there is, which pushes prices even higher. And by buying up $40 billion of mortgage securities every month, the Fed keeps mortgages readily available, which also keeps demand for housing higher than it otherwise would be. So, in those ways, the Fed is somewhat contributing to that problem.
Finally, I should mention that Fed policy isn’t static. While Powell and the FOMC are ignoring inflation for now, they’re about to begin ratcheting back on the Fed’s affirmative stimulus. They will soon begin “tapering” the $40 billion of mortgage bond purchases, eventually taking them down to zero. This will take a year or two. After that, they may begin very gradually raising interest rates. Or maybe not. The government and big corporations owe trillions, and if they have to pay higher interest on all that debt, it will blow big holes in federal budgets and corporate earnings. Some people wonder if Fed-suppressed interest rates are locked in for good, because it’s just to risky and expensive to let them rise.
Will Powell be reappointed? Maybe. I don’t see Biden benefiting from tighter monetary policy — less stimulus, higher interest rates, slower economic growth. Should he be? If you ask me, no.
I want tighter monetary policy — less money and debt creation, normal home and stock prices, better returns on savings. Reappointing Powell won’t bring that. I’d rather see someone like Lael Brainard (bio here), who is currently an FOMC member, take over the chair and chief policy influencer position.
But nobody’s asking me.