Biden plays it safe with continuity at the Fed

The policy differences between Jay Powell and Lael Brainard — the only names on Joe Biden’s shortlist for Federal Reserve chair — are narrow. The president was nevertheless sensible to prioritise continuity over change by renewing Powell for a second term. It is doubtful that picking Brainard would have had much impact on the speed with which the Fed plans to tighten in the near future, though the markets see her as mildly more dovish than Powell.

Either way, the Fed will start to withdraw its $120bn-a-month quantitative support for the US economy from next month, while futures markets have priced in two interest rate rises in 2022. Facing a potentially hazardous turning point for markets and the economy, Biden chose wisely. Together with Powell’s reappointment, Brainard’s elevation to vice-chair gives the impression of continuity in monetary policy with a more robust approach to regulation.

The Democratic left is unhappy with Biden’s decision, nonetheless. The gap between Powell and Brainard is far wider on bank regulation than on monetary policy. Elizabeth Warren, the Massachusetts senator, has called Powell “a dangerous man” for loosening capital and liquidity restrictions on US banks — moves that Brainard usually opposed. But political reality suggests the left’s disaffection will only improve the chances of a timely Powell confirmation in a 50:50 Senate.

Powell was elevated to the role by Donald Trump in 2018. Though he is a Republican, he resisted bullying by Trump before the pandemic to keep interest rates low in a heating economy. This implies Powell will have the necessary grit to withdraw the Fed’s extraordinary accommodation as Covid-19 recedes. Biden is likely to appease the left by picking Democrats to fill the three Fed vacancies, including the vice-chair for supervision.  

In addition to his confirmation, Powell will face two big challenges. The first is to control US inflation which, at 6.2 per cent last month, is at its highest in more than three decades. The Fed has consistently argued that this is a “transitory” problem caused by temporary disruption to the global supply chain. That may be so — and there are signs some of the bottlenecks may be coming unstuck. But the Fed has been late to recognise the breadth of goods shortages and the ensuing inflation risk.

It may need to shift more quickly than planned. The tapering of asset purchases, which are scheduled to end by next June, may have to happen more rapidly. The risk that higher inflation expectations might become anchored in the real economy is non-trivial. Modest tightening now could save the need for more severe contraction later.

The second challenge will be over the Fed’s widening remit, particularly on climate change. Powell has said global warming should be tackled by other government agencies. Brainard has been more receptive to Fed regulation of carbon financing. Biden’s statement stressed both Powell and Brainard “share my deep belief that urgent [Fed] action is needed”. This implies Powell has shifted his stance closer to what the European Central Bank and the Bank of England are doing. Indeed, the ECB on Monday warned European banks could “eventually” face higher capital charges if they failed to take climate risk seriously.

Such central bank thinking ought to be welcomed. But the political reaction, especially in the US, could be fissile. The Republican right will see Powell’s shift as a reason to vote against his nomination. Yet the majority of Democrats, and some Republicans, are likely to carry him over the line. A bipartisan confirmation would be good news for the Fed, and for the US economy.