The Federal Reserve is the most important economic agency in the country. Biden should treat it as such.
Joe Biden is still more than a month away from taking office, but already the basic tasks of his first year in office seem quite clear: He has to end the Covid-19 pandemic, and he has to end the recession and economic fallout from the pandemic.
Most attention on the latter has focused, understandably, on what relief package Biden will be able to pass through Congress. There’s a chance that a bipartisan effort to expand unemployment insurance benefits and state/local government aid will succeed under Trump, but if not Biden will be forced to negotiate a deal with either a Republican Senate or a 50-50 one with Vice President Kamala Harris breaking ties.
That’s economic job No. 1. But there’s another key aspect of Biden’s relief strategy that hasn’t gotten the attention it deserves: his Federal Reserve appointments. It might not get as much attention as an administration’s legislative priorities, but the Fed is extremely consequential, and past Democratic presidents like Barack Obama have ignored it to their detriment (and Trump, to his credit, has not).
While coverage of it is mostly limited to the business press, the Fed’s work has enormous consequences for everyday workers and consumers. One of its central jobs is setting the interest rate at which banks lend to each other overnight, and deciding the interest it pays on funds (“reserves”) that those banks keep at the Fed itself.
When the Fed raises interest rates, that ripples out through the whole economy. Because banks are paying more interest to borrow money they will then lend out, the interest rates they charge on everything from mortgages to auto loans to credit cards go up. Business loans becoming more expensive makes businesses less likely to expand or hire. That slows down the economy — and, conversely, lowering rates heats the economy up. So a Fed committed to rock-bottom rates is incredibly important for making sure the 2021 recovery is fast.
Biden will get at least one pick for the Federal Reserve Board of Governors upon taking office in January, and soon thereafter will have to decide on a pick to chair the Fed. These are likely to be among the most important domestic policy decisions he makes in his presidency, and he ought to prioritize getting dovish nominees — nominees who will keep interest rates low and prioritize employment over inflation— on the Board.
Why Biden should prioritize the Fed
To simplify drastically, the Fed has two major roles: regulating banks and related financial institutions, and conducting monetary policy (that is, adjusting the money supply to maintain stable inflation and low unemployment). Both of these are crucially important — the former especially for its potential to prevent financial crises — but the latter makes the Fed the single most important economic agency in the United States.
By pushing economic activity closer to its potential, the Fed generates, on an ongoing basis, hundreds of billions if not trillions of dollars’ worth of economic output that would otherwise be lost, with massive positive humanitarian consequences both in the US and abroad.
In recent decades, this has been achieved through “loose” policy of low interest rates and aggressive Fed purchases of bonds (“quantitative easing”). When the Fed fails, usually by being too “tight” in its policies, the consequences are equivalently dire. And good monetary policy is especially important during recessions and recoveries like the one the US finds itself in right now.
This is an odd recession, precipitated by a pandemic incapacitating or killing millions of workers and consumers, as well as preventing certain kinds of economic activity (indoor dining, gyms, etc.) from taking place. Fixing the overall pandemic has to come first. But as we get it under control, ramping economic activity back up is going to be crucial.
The Fed’s monetary policy is decided by the Federal Open Market Committee (FOMC). At full capacity, the FOMC has 12 members: seven members of the Federal Reserve Board of Governors, who are appointed by the president and confirmed by the Senate, plus the head of the New York regional Fed and a rotating group of four of the other 11 regional banks (Minneapolis, Dallas, Cleveland, and Philadelphia are in right now). The regional bank presidents are selected by members of their boards of directors, subject to the approval of the nationwide board of governors; the board of governors also has some say in who the directors of the regional banks are.
The upshot is the president has limited control over the selection of five of the 12 important decision-makers, and a high level of control over the other seven. And with one of those seven seats currently vacant, Biden will have the ability to shift the FOMC immediately.
The current state of play on the Fed
The Obama administration, despite taking office amid a massive economic collapse, did not prioritize Fed appointees early on, and when it did make picks, more often than not they leaned against measures to speed up the recovery, rather than pushing for them.
Jeremy Stein, the Harvard economics professor whom Obama appointed to the Board and served from 2012 to 2014, suggested that the Fed should consider raising interest rates and slowing down the economy for “macroprudential” reasons: inflicting pain early might prevent a bubble from developing and causing pain later. That theory is quite controversial within macroeconomics, whereas it’s clear that raising interest rates costs people jobs.
In other cases, the administration picked solid nominees who initially seemed committed to promoting employment growth with low interest rates, only for them to turn surprisingly hawkish. Former Chair Janet Yellen and Vice Chair Stanley Fischer, who had reputations as dovish when their terms began in 2014, instead pushed forward with an interest rate hike in 2015 that harmed the economic recovery. It’s certainly possible that an alternative regime (say under Fed Chair Larry Summers) would have been worse, but better still would have been for the Fed to simply not raise rates and allow the economy to continue to recover.
Trump has been much more attentive to the Fed, much to his chair Jay Powell’s chagrin; after appointing Powell in part because he reportedly thought Yellen was too short to be chair, Trump spent the rest of his presidency verbally abusing him in an effort to lower interest rates. That’s led to rampant speculation that Powell’s subsequent low interest rate policies were the result of Trump’s pressure. It seems likelier, as Josh Barro noted in a recent profile of Powell, that he is simply listening to stakeholders, like labor and businesses, who have urged the Fed to deemphasize worries about accelerating inflation and reemphasize the Fed’s mandate to maximize employment.
Trump has most recently made a lame-duck push to get more appointees confirmed. In mid-November, the Senate narrowly voted against Judy Shelton, a gold-standard-backing, crankish nominee Trump has put forward. In theory, the Senate could vote on her nomination again, but with a few Republicans opposing her and Arizona special election winner Sen. Mark Kelly (D) having since taken office and reduced the party’s majority, her nomination looks dead in the water.
Meanwhile, Christopher Waller, a career economist at the St. Louis regional Fed bank with a much more pro-employment record than Shelton, was narrowly confirmed on December 3. Despite unanimous Democratic opposition to Waller, he’s a pretty great addition from Biden’s perspective. He and his former boss and ally, St. Louis Fed president James Bullard, are outspoken “doves” who want the Fed to aggressively try to reduce unemployment and not worry too much about sparking inflation.
With Waller confirmed and Shelton all but rejected, Biden will have one vacancy to fill as soon as he takes office. But the Fed has a lot of turnover, and Republican members retiring is likely. Moreover, Powell’s term is up in February 2022, so in a few months Biden will need to decide whether to reappoint Powell or pick a replacement.
The candidates for a Biden Fed
There’s a good case for reappointing Powell. He mistakenly raised interest rates in 2018 but corrected his error by cutting them a year later, and has been extremely aggressive in using the Fed’s powers to expand businesses’ access to funds during the Covid-19 crisis.
Most importantly, Powell announced a new “monetary policy framework” in August 2020 that commits the bank to keeping interest rates near zero even if inflation exceeds its target of 2 percent per year, given that inflation has been lower than that level for much of the past decade. The framework also indicates that the Fed will not raise interest rates simply because it thinks unemployment has gotten sufficiently low, to what economists sometimes call its “natural rate.” That kind of reasoning motivated the 2015 and 2018 rate hikes, and Powell’s announcement suggested the Fed as an institution is foreswearing that reasoning in the near to medium term.
But Biden might want to put his own stamp on the institution. Reappointing Yellen, currently nominated to serve as treasury secretary, would make some sense; the 2015 hike was a blunder, but Yellen is an enthusiastic backer of the Fed’s new approach and seems like she’d be more dovish in a second term. Powell learned from his mistaken rate hike, and Yellen might learn from hers.
Two other names I’ve heard floated most frequently by Fed watchers as potential chairs are Lael Brainard, who has served on the Board of Governors since 2014, and Raphael Bostic, who leads the Atlanta Fed bank. Brainard was widely considered a possible treasury secretary until Yellen was picked, but she might be more effective as chair. She’s arguably the most dovish member of the Board currently, arguing in a late 2019 speech that rate hikes in recent years had been errors and that the urge to increase rates just to “normalize” was dangerous. She has also repeatedly dissented from Trump-era initiatives to weaken financial regulations, suggesting she’d be tougher on Wall Street than Powell.
Bostic would likely need to be appointed as a governor first; going straight from a regional bank to chair would be a big leap. But he would make history as the first Black and first openly gay Fed chair. That said, some advocates of full employment are skeptical of Bostic, arguing that his approach to monetary policy is more reminiscent of the school of thought that led to the job-costing 2015 and 2018 rate hikes than Powell’s new, more dovish approach. He has suggested, echoing Stein, that getting unemployment “too low” can lead to bubbles and excessive risk-taking. Elsewhere he’s written that the view that the Fed should force unemployment as low as possible is a “short-sighted perspective that doesn’t ultimately serve the economy and American workers well.” That would be an unfortunate view to have in the chair’s seat, but it’s possible Bostic’s views have evolved.
Setting aside the chair job, there are many options for filling the open governor seat, including some Republicans who could be easy Senate confirmations. Whereas government spending and taxes are issues that are very polarized along party lines, there are Fed hawks and doves on both sides of the aisle, which means Biden could pick some right-leaning economists and still get the policies he wants. George Mason’s David Beckworth and Bloomberg’s Karl Smith both come to mind as libertarian-leaning figures who’d fit the bill.
Some other names (of various ideological backgrounds) I’ve heard touted from advocates for high-employment monetary policy are Julia Coronado, a veteran Fed economist; Obama Treasury Department veteran Ernie Tedeschi; Paul McCulley, a former chief economist at the investment manager PIMCO; Fed veteran Claudia Sahm; former Minneapolis bank president Narayana Kocherlakota; and, the most cited name I’ve heard, Bill Spriggs, an economist at Howard University and chief economist for the AFL-CIO.
Spriggs would only be the fourth Black member of the Board of Governors, a testament to how terribly the institution has done on racial diversity over its 107-year history. Luckily, there are a lot of strong Black candidates, from Michigan State University’s Lisa Cook (an adviser to the Biden transition) to the Economic Policy Institute’s Valerie Wilson. Spriggs would also be the only governor in history with a background in organized labor, which would be an important step for an institution that has had tight ties to capital (and specifically the financial sector) but has occasionally failed to advance the interests of workers.
I don’t want to exaggerate the Fed’s importance; in some ways, the most important thing Biden can do is make sure it stays the course and maintains hyper-low interest rates throughout his term, barring a sudden shocking rise in inflation. The Fed could experiment with other ways to aid the recovery, like ramping up its purchases of government debt, or using debt purchases as a way to fund the federal government through printing money, or explicitly trying to keep the interest rate on government debt at or near zero so Congress is more inclined to enact a stimulus package. But those would be very aggressive, last-resort moves.
Still, doing no harm is important if Biden wants this recovery to stick. And doing no harm begins with taking the Fed seriously and thinking hard about whom to pick, starting right now.
Author: Dylan Matthews
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