President Joe Biden has nominated current Federal Reserve Chairman Jerome Powell to a second four-year term, in an announcement that follows months of speculation and indecision as the Biden administration resisted calls from factions of the Democratic Party to remove Powell.
With Powell likely to be confirmed, he now faces the unenviable task of navigating the current inflationary surge and quelling any possibility of inflation spiraling out of control.
Earlier this month, the Bureau of Labor Statistics reported that inflation hit 6.2 percent over the past 12 months, the largest annual increase in over 30 years.
This surge in inflation is at least in part driven by measures taken against the pandemic. With supply chain disruptions and the current global economic recovery, the perfect storm has been brewing for global inflation. In the United States, the largest movers in inflation have been areas directly affected by these forces—energy prices and used car and truck prices, have jumped 30 percent and 26.4 percent, respectively, over the past 12 months.
While higher energy prices and supply bottlenecks are a global phenomenon, U.S. inflation is higher than that of almost all other developed countries, which points to domestic conditions also playing a role. In particular, the Fed aggressively expanded its balance sheet from the onset of the pandemic, which has been amplified by an unprecedented fiscal expansion, first started by President Donald Trump’s stimulus checks and continued by Biden’s American Rescue Plan.
The total fiscal expansion means that the combined fiscal deficits from 2020 and 2021 have totaled close to $6 trillion (or 27 percent of gross domestic product).
A growing chorus of economists is concerned that the current surge in inflation will become persistent. Most prominently, former U.S. Treasury Secretary Larry Summers sounded the alarm of potential inflation early and has now pointed the finger squarely at U.S. domestic policy.
“If you put too much water in the bathtub, it starts to overflow,” Summers warned in March.
How Will the Fed Contain Inflation?
The Fed now must decide how to wind down its aggressive monetary expansion. It has the tools to fight inflation, but how it accomplishes that without stalling the economy is the key question. Tighten too quickly and it risks halting the economic recovery; tighten too slowly and it risks further increases in inflation.
The Fed has already started to change its approach. Acknowledging the growing threat of inflation earlier this month, the Federal Reserve Board decided to pare its purchases of Treasuries by $10 billion per month. But despite the economic recovery, policy still remains very accommodative.
Whether the tapering will be enough to tame inflation and generate a “soft landing” is an open question. Market indicators are currently giving some mixed signals. Market inflation expectations believe inflation will average 3 percent over the next five years (the Federal Reserve targets 2 percent average inflation). But longer-term expectations continue to show faith in the Fed with the 5-year, 5-year forward inflation expectations (which measures the average inflation over five years starting five years from now) is still tracking just above 2 percent.
Powell and the Future Federal Reserve
Outside of inflation, Powell also will need to navigate some more existential questions facing the central bank. This comes as Powell’s reappointment, though expected, wasn’t guaranteed. A faction of Democrats favored removing Powell due to the perception of him being soft on banking regulation and climate change.
Sen. Elizabeth Warren (D-Mass.) earlier this year called Powell a “dangerous man” to chair the Fed, arguing that deregulatory actions taken under Powell’s leadership have destabilized the U.S. banking system.
Progressives reportedly advocated for Lael Brainard, who was appointed as vice-chair of the Fed. Despite Powell and Brainard having broadly similar opinions on monetary policy, Brainard’s views on other facets of the central bank differ from Powell’s. For example, Brainard has dissented to the financial deregulation, has emphasized the need to consider climate change when stress-testing banks, and wants the Fed to develop its own digital currency.
Powell’s next term as Fed chair will be critical in determining the direction and role of the central bank in these highly political and ever-changing areas.