Will Biden Make a historic mistake at the Fed?

BERKELEY —  In 1987, Alan Greenspan was appointed by Republican President Ronald Reagan to chair the US Federal Reserve (Fed) board of governors, succeeding Paul Volcker. Eight years later, President Bill Clinton, a Democrat, was impressed by Greenspan’s willingness to use monetary policy to offset his administration’s fiscal retrenchment. This kept growth from stalling in the 1990s, and Greenspan did it despite partisan opposition from Republicans who denounced him for too-loose monetary policy. In 1996, Clinton reappointed Greenspan to a third term, and then to a fourth in 2000.

But Greenspan’s nurturing of the (highly beneficial) 1990s dot-com boom turned out to be the last time he would act bravely, wisely, and in a non-partisan fashion. In the 2000s, he put partisan loyalty first, endorsing Republican President George W. Bush’s 2001 and 2003 tax cuts even though he evidently considered them to be bad policy.

When Fed Governor Edward Gramlich warned that mortgages, derivatives, and mortgage derivatives demanded much closer scrutiny and regulation, Greenspan rejected this argument, insisting that it was not his place to get in the way of lenders who want to lend to home buyers who want to borrow. Never mind that this macroprudential philosophy was in direct contradiction to the one famously articulated by his earlier predecessor, William McChesney Martin, who in 1955 explained that the Fed chair’s job is to remove the punch bowl before the party gets too raucous, even though partygoers are likely to protest.

When Greenspan retired in January 2006, he was succeeded by Ben Bernanke, a Bush appointee who impressed Democratic President Barack Obama with his willingness to work on a bipartisan basis to push the perceived limits of monetary policy in fighting the Great Recession. In 2009, Obama duly reappointed Bernanke, who held the line by continuing the Fed’s quantitative-easing (QE) policies despite howls of outrage from Republicans.

By 2010, Republican economists and non-economists had decided that their top priority was to ensure that Obama was a “one-term president”. They started demanding rapid normalisation of monetary policy, which was certain to produce higher unemployment, and dismissed as a sham whatever prosperity had been created by monetary expansion.

The prosperity was not a sham, but it was meager enough that the argument gained traction. In December 2009, the US employment-to-population ratio was 58.3 per cent, still far below its pre-crisis level of 63.4 per cent (in December 2006). Three years later, in December 2012, it was only 58.7 per cent; and when Bernanke stepped down, in January 2014, it had not risen any higher.

Not surprisingly, Bernanke was bitterly disappointed by the anemic post-2008 recovery. As recently as the late 1990s, he had argued vociferously that the Bank of Japan should do whatever it takes to restore the Japanese economy to full employment. But things looked different to him when he left academia to become a central banker. Not until after his departure from the Fed did the US employment-to-population ratio start rising at the one-per centage-point annual rate needed to bring the economy within striking distance of full employment. It reached that level under single-term Republican President Donald Trump, who replaced Obama’s second Fed chair, Janet Yellen, with Jerome Powell.

Now, it appears that President Joe Biden, a Democrat, is poised to reappoint Powell to another four-year term. Why he would do such a thing is beyond me. Powell’s views on financial regulation and macroeconomic management are not even remotely aligned with those of the Democratic near-consensus. Though he has spent the past four years following interest-rate and QE policies that do accord with the prevailing Democratic view, it is important to consider the two main factors behind this.

The first reason is that the Republican Party has been split down the middle, and thus neutralised, by a bitter conflict between the hard-money kneejerk instincts of GOP worthies and the soft-money kneejerk instincts of Trump the real-estate developer, for whom money can never be too cheap. The second reason is that Fed Governor Lael Brainard has been extremely persuasive in arguing that the current neutral rate of interest is still below zero, and that the supply-shock-driven inflation caused by the COVID-19 pandemic should be accommodated.

The first factor is fading away. Without Trump in office, and without the fear that tight money will erode vote margins in the short run, Republicans are about to unite overwhelmingly behind the talking point that monetary policy needs to be substantially tightened immediately. Powell, being a Republican worthy, will listen and toe this line.

If you think that the standard Republican hard-money perspective is good policy at this stage in the recovery, that is your prerogative. But if you do not sympathise with this view, you should be staunchly against Powell’s reappointment. The obvious alternative is Brainard, a former academic economist and under secretary of the US Department of the Treasury who has served on the Fed board since 2014.

To reappoint Powell, Biden and his advisers would have to offer a convincing argument against Brainard. Are they going to tell us that she lacks the necessary technical skills, experiences, charisma, or persuasiveness on monetary and regulatory policy? I certainly hope not. Brainard stayed the course at her post through the dark days of the Trump administration. For a Democratic administration that currently enjoys only the barest majority in the Senate, her appointment as Fed chair should be an easy decision.

J. Bradford DeLong, a former deputy assistant US Treasury secretary, is professor of Economics at the University of California, Berkeley and a research associate at the National Bureau of Economic Research. Copyright: Project Syndicate, 2021. 

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