Powell’s Shifting Stance
It’s become increasingly clear that Federal Reserve Chairman Jerome Powell is neither apolitical nor purely data-dependent. His actions speak for themselves. When Powell was up for renomination, he maintained interest rates below 1% and significantly expanded the Fed’s balance sheet, only narrowly avoiding breaching the $9 trillion mark in an unprecedented display of monetary creation. Despite facing 40-year-high inflation, Powell dismissed the notion of raising interest rates by three-quarters of a percent, attributing inflation to being “transitory.”
However, following his reconfirmation by the Senate for a second term as chairman, Powell swiftly delivered four consecutive increases of three-quarters of a percent in interest rates. He also took steps to reduce the size of the Fed’s balance sheet, belatedly addressing the issue of runaway inflation.
Unintended Consequences
While these moves by the Fed may have short-term effects that include a slowdown in economic growth and increased unemployment, they are necessary to prevent asset bubbles and the problems caused by artificially low interest rates. In March 2023, a series of bank collapses illustrated just how crucial it is to address these issues.
Furthermore, if Powell had allowed interest rates to rise naturally to offset multi-trillion-dollar federal deficits, the economy would have likely ground to a halt as government spending crowded out the private sector. The cost of servicing the federal debt would have reached astronomical levels, potentially surpassing the current annualized rate of $1 trillion.
By keeping interest rates too low for an extended period, both the government and consumers have accumulated staggering debt, fueling spending but also creating the conditions for a future collapse. Powell himself warned about this in October 2012 when he cautioned that persistently low interest rates were encouraging excessive risk-taking and nurturing a bubble that would result in significant losses when rates eventually rise.
Political Factors at Play
The future of Powell’s term as chairman at the Fed hinges on President Joe Biden’s reelection. Former President Donald Trump has made it clear that he intends to replace Powell if he is given the opportunity. With that in mind, the likelihood of a return to low interest rates and increased money creation, providing a short-term boost to economic growth and preventing a deeper banking sector crisis, becomes apparent. However, such policies would also pave the way for a resurgence of inflation, although this may not become a significant concern until after the 2025 election.
Learning from Past Mistakes
It’s worth noting that the Federal Reserve appears to be repeating the catastrophic mistakes of the 1970s. After successfully combating inflation, the Fed resumed its money creation practices, resulting in even more severe inflation and the need for then-Fed Chair Paul Volker’s aggressive measures. The subsequent back-to-back recessions in 1980 and 1981-82 left a lasting impact.
Understanding this history, it comes as no surprise that institutions such as the Fed should be limited in their power. Even President Ronald Reagan chose to replace Volker with Alan Greenspan in 1987, ultimately leading to easy-money policies that contributed to major financial crises, including the bailout of Long Term Capital Management and the housing bubble.
In summary, it is time to dispel the belief that the Federal Reserve under Powell operates as an apolitical body. Powell’s actions demonstrate a more nuanced reality. The consequences of recklessly maintaining low interest rates and excessive money creation must be acknowledged. By reducing its influence, the Fed can prevent future crises and promote a more stable economic environment.