Jerome Powell: The Pragmatic Pivoter

This is an excerpt from Chapter 8 of my 2020 book, Fed Watching for Fun & Profit. It is particularly relevant now that Fed Chair Jerome Powell seems to be pivoting once again. He pivoted in late 2018 and turned less hawkish. He turned dovish during the second half of 2019 and extremely dovish in response to the pandemic as Melissa Tagg and I discussed in our 2021 book, The Fed and the Great Virus Crisis. Now he is turning hawkish again.

Following the Script

Jerome Powell’s term as Fed chair started on February 5, 2018. Trump could have appointed Yellen to another term as Fed chair. It didn’t take long for the President to regret his choice of Powell instead.

Powell has a law degree from Georgetown University. He also had lots of experience on Wall Street. He became a Fed governor on May 25, 2012. I had expected when Powell took over the Fed that he would continue pursuing Yellen’s gradual normalization of monetary policy; I’ve had to adjust that view because Powell has adjusted his.

In his debut congressional testimony, Powell signaled that his leadership would not differ much from Yellen’s. He emphasized in that semiannual testimony on monetary policy—delivered to the House of Representatives on February 27 and the Senate on March 1—that the change in Fed leadership wouldn’t significantly alter the course of monetary policy.133 He said that he would continue the “gradual” pace of normalization unless the incoming data suggested doing otherwise. That was widely interpreted to mean that the three or four 25-basis-point rate hikes that the FOMC projected at the December 2017 meeting (under Yellen) remained the likely scenario for 2018 (under Powell). Initially, this was all very reassuring to financial markets eager to understand what the regime change would mean in terms of interest rates.

His testimony was upbeat on the prospects for the economy: “While many factors shape the economic outlook, some of the headwinds the U.S. economy faced in previous years have turned into tailwinds,” he said. “In particular, fiscal policy has become more stimulative and foreign demand for U.S. exports is on a firmer trajectory. Despite the recent volatility, financial conditions remain accommodative.”

On inflation, Powell told Congress: “We continue to view some of the shortfall in inflation last year as likely reflecting transitory influences that we do not expect will repeat.” But he explained: “In this environment, we anticipate that inflation on a 12-month basis will move up this year and stabilize around the FOMC’s 2 percent objective over the medium term.”

Powell came across as a straight-shooter—willing to admit to uncertainty and dropping the often-ambiguous verbiage of his predecessors. In response to a question about whether unemployment could drop further if sidelined workers decided to rejoin the labor force, he honestly answered: “The only way to know is to . . . find out.”

Powell was pragmatic too. He was asked about the discrepancy in the actual federal funds rate and the substantially higher one suggested by the widely followed Taylor Rule.134 Powell responded that such rules can be helpful, but the targets they produce can’t be viewed in a vacuum. His views on the subject were consistent with Yellen’s: “Personally, I find these rule prescriptions helpful. Careful judgments are required about the measurement of the variables used, as well as about the implications of the many issues these rules do not take into account.”

Powell’s first press conference as Fed head, on March 21, was a non-event.135 He told investors merely what they had learned from his congressional testimony: that he would remain on the gradual policy path that his predecessor set out before him. His outlook for the US economy remained upbeat with the headwinds-turned- to-tailwinds sentiment expressed in his testimony, though that specific metaphor wasn’t reused in the press conference. But as in the testimony, Powell repeated the word “gradual” to describe the pace of federal funds rate increases several times.

Powell was trained as a lawyer rather than as an economist. So he is much less infatuated with economic models and theories than his three predecessors who have PhDs in economics. That’s a good thing, in my opinion, since central bankers have been too dependent on unobservable theoretical measures of economic “slack” such as the NAIRU and potential output.

His matter-of-factness regarding models and theories was evident during his first press conference. Powell observed that “the relationship between changes in slack and inflation is not tight,” which puts it simply! When asked about the shape of the yield curve, Powell observed that an inverted yield curve might not signal a recession as it had consistently in the past when “inflation was allowed to get out of control.” So “the Fed had to tighten . . . and put the economy into a recession.” He concluded, “That’s really not the situation we’re in now.” I agreed with his assessment.

Powell remained on course to gradually normalize monetary policy through the end of 2018. Recall that the federal funds rate range had been fixed at 0.00%–0.25% from December 15, 2008 through December 15, 2015. Under Yellen, the federal funds rate was raised to 0.25%–0.50% on December 16, 2015 and again to 0.50%–0.75% on December 14, 2016. During 2017, still under Yellen’s watch, the federal funds rate was raised by three additional quarter-point increments at the FOMC meetings during March (0.75%–1.00%), June (1.00%–1.25%), and December (1.25%–1.50%).

Powell followed Yellen’s playbook during his first FOMC meeting as the chair of the committee. The federal funds rate range was raised to 1.50%–1.75% in March (Fig. 24). He followed that up with hikes during June (1.75%–2.00%), September (2.00%–2.25%), and December (2.25%–2.50%). It was all going according to plan until it wasn’t.

The financial markets tested Powell during the fall of 2018, much as they had tested Greenspan during October 1987, Bernanke during May and June of 2013, and Yellen during March 2014.

Without much fanfare, the stage was set for the upcoming drama at Powell’s first meeting as chair of the FOMC. The March 21, 2018 dot plot showed the committee’s median forecast for the federal funds rate in 2020 had been raised from 3.10% at the previous meeting to 3.40%, further above the “longer run” forecast of 2.90%, which had also been raised from 2.80%. (See Appendix 6, FOMC Projections for the Federal Funds Rate, 2017–2022.)

By then, the markets were starting to focus more on the outlook for monetary policy in 2019 and 2020. The FOMC’s June and September dot plots continued to project federal funds rates of 3.10% in 2019 and 3.40% in 2020. If the US economy continued to perform as well as the Fed expected, the federal funds rate would be raised to 3.25%–3.50% during 2020. That would have been two 25-basis-point hikes above the SEP’s longer-run projection of 3.00% for the federal funds rate.

Suddenly, changed language in the September 26 FOMC statement drew more attention to the dot plot projections for 2020. The passage “The stance of monetary policy remains accommodative”—which had appeared in every FOMC statement since December 16, 2015, when the Fed’s latest rate-hiking program began—had been removed for the September 26 statement.

At his September 26 press conference, Powell said that the language simply had “outlived its useful life,” so the Fed would continue its gradual rate increases toward a neutral stance. Nevertheless, some Fed watchers interpreted the deletion to mean that the Fed was setting up for more aggressive rate increases despite Powell’s reassurances to the contrary. The markets were starting to fear that the Fed might be turning from accommodative to neutral to outright restrictive, given the strength of the economy. Stock prices began to fall.

During the Q&A of his September 26 press conference, Powell was asked whether the Fed might end the tightening cycle in a “restrictive posture,” as Fed Governor Lael Brainard had suggested in a September 12 speech. Powell responded: “It’s very possible.” He added: “Maybe we will keep our neutral rate here [i.e., at 3.00%], and then go one or two rate increases beyond it.” In her speech, Brainard explained:

"In the latest FOMC SEP median path, by the end of next year, the federal funds rate is projected to rise to a level that exceeds the longer-run federal funds rate during a time when real GDP growth is projected to exceed its longer-run pace and unemployment continues to fall. The shift from headwinds to tailwinds may be expected to push the shorter-run neutral rate above its longer-run trend in the next year or two, just as it fell below the longer-run equilibrium rate following the financial crisis."136

Investors’ fears were further confirmed by the release of the September FOMC meeting minutes on October 17. The word “restrictive” appeared for the first time during the current economic expansion. And it did so twice (emphasis mine):

"Participants offered their views about how much additional policy firming would likely be required for the Committee to sustainably achieve its objectives of maximum employment and 2 percent inflation. A few participants expected that policy would need to become modestly restrictive for a time and a number judged that it would be necessary to temporarily raise the federal funds rate above their assessments of its longer-run level in order to reduce the risk of a sustained over-shooting of the Committee’s 2 percent inflation objective or the risk posed by significant financial imbalances. A couple of participants indicated that they would not favor adopting a restrictive policy stance in the absence of clear signs of an overheating economy and rising inflation."137

It increasingly seemed that monetary policy and fiscal policy were on a collision course, as the former was tapping on the economy’s brakes while the latter was keeping the pedal to the metal. President Trump and Larry Kudlow, the director of the National Economic Council, publicly chastised the Fed for raising interest rates. They firmly believed that their supply-side policies of deregulation and tax cuts would boost productivity-led economic growth without heating up inflation, as long as monetary policy didn’t get in the way.

That conflicting mix of fiscal and monetary policies sent stock prices plunging 19.8% from September 20 through December 24, but Powell got most of the blame (Fig. 25). Some off-the-cuff comments he made in an October 3 interview with Judy Woodruff heightened investors’ anxiety about the Fed’s policy course:

So interest rates are still accommodative, but we’re gradually moving to a place where they will be neutral, not that they’ll be a restraint on the economy. We may go past neutral, but we’re a long way from neutral at this point, probably.138

That contradicted the deletion of the accommodative language from the latest FOMC statement, and implied that the Fed would be raising interest rates through 2020 as outlined in the dot plot. More confusion ensued. On October 25, in his first public speech as Fed vice chair, Richard H. Clarida echoed Powell, saying, “However, even after our September decision, I believe U.S. monetary policy remains accommodative.” To say so was a rookie’s mistake by Clarida, but Powell should have known better.

Clarida walked his October 25 statement back for himself, and maybe for Powell too, on Friday, November 16, saying in a CNBC interview: “As you move in the range of policy that by some estimates is close to neutral, then with the economy doing well it’s appropriate to sort of shift the emphasis toward being more data dependent.” He was seconding Atlanta Fed President Raphael Bostic. The day before, on November 15, he said the Fed is “not too far” from reaching a “neutral” rate. But the investment community was left scratching their heads: There’s a big difference between Clarida’s “close to” and Bostic’s “not too far from” on one hand and Powell’s “a long way off from” on the other.

Powell’s Pivot

In my commentaries and in a few press interviews, I called on the Fed to pause its rate hiking. On October 29, I wrote: “What’s the rush to raise interest rates? Why not pause the rate hikes and assess how the economy is responding to them so far? . . . In my opinion, the plunge in stock prices, especially the ones of cyclical companies, suggests that the economy may not be as strong as the Fed perceives and that inflationary risks remain low.” CNBC’s Jim Cramer was saying the same, along with the White House.

In a November 14 Q&A discussion led by Dallas Fed President Robert Kaplan, Powell turned more dovishly cautious, comparing monetary policy to walking through a room full of furniture when the lights go out. “What do you do? You slow down. You stop, probably, and feel your way,” he said. “It’s not different with policy.” He also warned against relying too much on data that are revised frequently. He said, “You pick things up sooner talking to business people because they start to feel it, and then it shows up in the data.”139

My November 19 Morning Briefing was “On Your Mark, Get Set, Pause.” I wrote:

"President Donald Trump and Larry Kudlow, his economic adviser, have been calling for Fed officials to pause their interest-rate hiking. So has CNBC’s Jim Cramer. And so have I. Fed Chair Jerome Powell and his colleagues may be starting to get the message and act accordingly."

The Tuesday November 27 issue of The Wall Street Journal included an article by Nick Timiraos titled “Fed Shifts to a Less Predictable Approach to Policy Making.”140 It was based on interviews with Fed officials who “will be deciding whether and when to raise interest rates more on the basis of the latest signs of economic vigor—such as in inflation, unemployment and growth—and less on forecasts of how the economy is expected to perform in the months and years to come.” They were admitting that they are more uncertain about the level of the neutral interest rate and were “looking for clues in markets and economic data that might suggest whether this point might be higher or lower.”

The very same day, in a November 27 speech, Clarida reiterated that both the neutral rate of interest and the unemployment rate that is consistent with stable inflation are unmeasurable. So needing to get a fix on them “supports the case for gradual policy normalization, as it will allow the Fed to accumulate more information from the data about the ultimate destination for the policy rate.” That also supported the case for longer pauses in between rate hikes, in my opinion.141

In a speech at The Economics Club of New York on Wednesday, November 28, Powell confirmed my assessment when he said, “Interest rates are still low by historical standards, and they remain just below the broad range of estimates of the level that would be neutral for the economy—that is, neither speeding up nor slowing down growth.”142 Stock investors jumped for joy upon hearing Powell’s “just below” comment.

The next day, on November 29, the minutes of the November 7–8 FOMC meeting came out.143 The word “restrictive” had been dropped. In my November 29 commentary, I exuberantly wrote:

The Fed’s critics will say that now we have a fourth Fed chair in a row providing the stock market with a put, i.e., the Powell Put. Maybe so. However, if Janet Yellen was the “Fairy Godmother of the Bull Market,” as we often fondly called her, then Powell for now is the bull market’s Santa. The Santa Claus rally that started on Monday should drive the S&P 500 back to retest its 9/20 record high around 2900 by the end of this year.

My optimism was about a month too early. The Fed’s message remained confusing. Indeed, Powell inadvertently freaked the markets out again at his December 19 press conference when he responded to a question on monetary policy as follows: “So we thought carefully about this, on how to normalize policy, and came to the view that we would effectively have the balance sheet runoff on automatic pilot and use monetary policy, rate policy, to adjust to incoming data.”144

The Fed’s message became clearer and increasingly dovish at the start of the new year. On Friday, January 4, 2019, along with a blowout employment report, dovish remarks from Powell sent the DJIA soaring 746 points and the S&P 500 jumping 8.4%. Speaking on a panel with former Fed chairs Ben Bernanke and Janet Yellen at the annual meeting of the American Economic Association and Allied Social Science Association in Atlanta, Powell emphasized that the monetary policy path was not on autopilot.145

Powell said that the Fed is willing to be “patient.” He noted that to keep the US economic expansion on track, “there is no preset path for policy.” He stated: “We will be prepared to adjust policy quickly and flexibly and use all of our tools to support the economy should that be appropriate.” Powell used the example of early 2016, when the Fed expected to raise rates four times but did so only once as the economy weakened. Later, the gradual path of rate hikes resumed during 2017 and 2018. “No one knows whether this year will be more like 2016,” he said. “But what I do know is that we will be prepared to adjust policy quickly and flexibly.”

In the past, Powell was wary of the models that drove policy for his predecessors. Powell specifically questioned the relationship between wages and broader inflation. Confirming this view, he said on the panel that the “link between . . . wage inflation and price inflation is pretty weak.” He added: “Wages going up isn’t necessarily inflation.”

Equity markets suddenly seemed to matter a lot more to Powell. He even said that the Fed was starting to give more weight to the markets, and so might pause rate hiking for a while. Markets are “obviously well ahead of the data,” but “we’re listening very carefully,” Powell said. I concluded in my January 7 commentary that “[t]he Dow Vigilantes may have gotten their Powell Put!”

The Fed’s balance-sheet reduction was not an “important part of the story,” according to Powell. But “if we reached a different conclusion, we wouldn’t hesitate to make a change.” For perspective, the Fed’s QE programs following the 2008 recession led the Fed to grow its balance sheet to more than $4.5 trillion. The Fed had been rolling off $50 billion per month of that since October 2017. Some viewed this as quantitative tightening. So Powell’s statement that the Fed is flexible (and not on “automatic pilot,” as he had said during his December 19 press conference) came as a relief to investors. Interestingly, Powell read his initial remarks from a script, presumably to avoid another off-the-cuff gaffe.

Powell’s January 30, 2019 press conference marked what came to be known as the “Powell Pivot.”146 He confirmed that he was becoming more patient and flexible regarding rate hiking in 2019, consistent with the FOMC consensus stance apparently emerging. His opening remarks included lots of reasons to pause interest-rate increases, notwithstanding December’s signs of economic strength. The press conference, especially the Q&A session, seemed to be more scripted than his prior ones.

Powell’s take on the stance of monetary policy shifted from a “gradual” tightening approach in December 2018 to “a patient, wait-and-see approach” in January 2019. Consider the following points on which Powell pivoted:

????Appropriate. In December, “two interest rate increases over the course of next year” was his expectation. In January’s press conference, he called the current policy stance “appropriate” several times. “[T]he case for raising rates has weakened somewhat,” he said. Citing “growing evidence of cross-currents,” Powell said that “common sense risk management suggests patiently awaiting greater clarity.” He added, “We think there’s no pressing need to change our policy stance and no need to rush to judgment.”

????Near neutral. December’s press conference found Powell implying there was room to raise interest rates, as he said they’d reached the “bottom end” of what might be considered a “neutral” range (i.e., where rates would neither accelerate nor slow the economy). He also mentioned the possibility of “circumstances in which it would be appropriate” for the Fed to raise rates “past neutral.” In January’s press conference, he said: “[O]ur policy rate is now in the range of the Committee’s estimates of neutral.” No intention of moving toward a restrictive stance was indicated as it was in December.

????Cross-currents. In December, Powell dismissed the economy’s emerging downside risks, or “cross-currents”—including financial market volatility and tightening financial condition. They didn’t fundamentally alter the outlook, he said. At the January press conference, however, Powell changed his tune, saying that cross-currents could result in a “less favorable outlook.” Slow growth in Europe and China, Brexit, ongoing trade negotiations between the US and China, and the effects from the partial government shutdown coupled with weakness in surveys of businesses and consumer sentiment gave “reasons for caution,” he said. He also suggested that the upside risks to the economic outlook, including the “risk of too-high inflation,” had diminished.

????No decisions. In December, Powell said that he “would effectively have the balance sheet runoff on automatic pilot,” adding “I don’t see us changing that.” That changed in January, when he stated that “we will not hesitate to make changes” to balance-sheet policy. He added that “no decisions have been made” on the plan for balance-sheet normalization and that there are a lot of moving “pieces.”

????Patient. During his January press conference, Powell mentioned the words “patient” or “patience” a total of eight times, four times in his opening remarks and four times during the Q&A. This compares with only once during the Q&A of the December press conference.

In a February 6 interview on CNBC, former Fed Chair Yellen said interest rates could go up or down. “It’s not out of the question that the Fed may need to raise rates again,” she said. But then she added: “If global growth really weakens and that spills over to the United States, or if financial conditions tighten more and we do see a weakening in the US economy, it’s certainly possible the next move is a cut, but both outcomes are possible.”147 Echoing Powell’s January 4 comments, she also recalled the unexpected policy shifts of 2016 to emphasize the importance of maintaining policy flexibility.

Powell gave his semiannual testimony on the economy before the Senate Banking, Housing and Urban Affairs Committee on February 26.148 If his goal was to make it as boring as possible so as not to disturb markets, he succeeded. That’s a compliment because Powell’s previous off-the-cuff style caused a lot of market havoc. Powell seemed to have quickly learned during his short tenure as Fed chair that credible messaging is key. So his basic message to Congress, and financial markets, was that the Fed will be patient with rates, cautious and flexible with the balance sheet, and mindful of global risks.

Powell’s Pirouette

Stock prices soared during the first few months of 2019 as Powell’s Pivot morphed into Powell’s Pirouette. The Fed chair was still talking about normalization in a March 8, 2019 speech titled “Monetary Policy: Normalization and the Road Ahead.”149 Powell had the following to say about the normalization of monetary policy:

"Delivering on the FOMC’s intention to ultimately normalize policy continues to be a major priority at the Fed. Normalization is far along, and, considering the unprecedented nature of the exercise, it is proceeding smoothly. I am confident that we can effectively manage the remaining stages." The words “normal” or “normalization” appeared 27 times in his speech.

For the first time, Powell specified the expected endpoint for the wind down of the Fed’s balance sheet. Until now, various Fed officials had said that the Fed would likely return the balance sheet to a level higher than it was before the recession (i.e., a new normal). Total assets on the Fed’s balance sheet increased by $3.6 trillion from $0.9 trillion at the start of 2008 to a peak of $4.5 trillion during February 2016. Since then, assets had fallen by $0.6 trillion to $3.9 trillion at the time of Powell’s March speech.

Powell said that “something in the ballpark of the [fourth-quarter 2019] projected values may be the new normal. The normalized balance sheet may be smaller or larger than that estimate and will grow gradually over time as demand for currency rises with the economy. In all plausible cases, the balance sheet will be considerably larger than before the crisis.” As for the normality of the federal funds rate, Powell reiterated that the “federal funds rate is now within the broad range of estimates of the neutral rate— the interest rate that tends neither to stimulate nor to restrain the economy.”

In the March 8 speech, Powell did his best to convince Fed watchers and other onlookers to pay less attention to the FOMC’s dot plot. Don’t look too closely at the Fed’s dot plot or you might miss the larger monetary policy picture, warned Powell. To make his point, he showed two unusual images: an unrecognizable close-up of a bouquet of flowers from impressionist painter Georges Seurat’s “A Sunday Afternoon on the Island of La Grande Jatte” and a very recognizable image of the full painting. He warned that monetary impressionists may not be seeing the forest for the trees, to mix up the metaphor.150

This was not the first time that a Fed chair had provided Fed watchers with an art class on interpreting the Fed’s dot-based pictures of monetary policy. In his speech, Powell reviewed two previous instances. In 2014, the dots caused “collateral confusion,” according to then-Fed Chair Janet Yellen, when the markets misread the Fed’s intentions. She stated that what matters more than the dots is what is said in the FOMC statement released after each meeting. Similarly, former Fed Chair Ben Bernanke once said that the “dots” are merely inputs to the Fed’s policy decision making; they don’t account for “all the risks, the uncertainties, all the things that inform our collective judgement.”

Powell’s Pirouette occurred on June 4, in his opening remarks at a conference in Chicago.151 He got to the point in the second paragraph of his written remarks:

I’d like first to say a word about recent developments involving trade negotiations and other matters. We do not know how or when these issues will be resolved. We are closely monitoring the implications of these developments for the U.S. economic outlook and, as always, we will act as appropriate to sustain the expansion, with a strong labor market and inflation near our symmetric 2 percent objective.

Fed watchers immediately concluded that the next move by the Fed might be to lower the federal funds rate rather than to raise it, sending the S&P 500 to another record new high.

Interestingly, the rest of his speech suggested that Powell and his colleagues had become totally obsessed with the “effective lower bound” (ELB) for the federal funds rate. Indeed, the abbreviation “ELB” appeared 26 times in his speech. Powell never explicitly defined ELB, however. In the past, Fed officials were more explicit, calling it the “zero lower bound” (ZLB). In his March 8 speech, Powell stated: “Just over 10 years ago, the Federal Open Market Committee . . . lowered the federal funds rate close to zero, which we refer to as the effective lower bound, or ELB. Unable to lower rates further, the Committee turned to two novel tools to promote the recovery.”152

In his latest speech, Powell was concerned that the federal funds rate was too close to the ELB. He was also worried about what the Fed can do when the federal funds rate falls to the ELB:

"The next time policy rates hit the ELB—and there will be a next time—it will not be a surprise. We are now well aware of the challenges the ELB presents, and we have the painful experience of the Global Financial Crisis and its aftermath to guide us. Our obligation to the public we serve is to take those measures now that will put us in the best position [to] deal with our next encounter with the ELB."

Leaving no doubt about his concern, Powell said: “In short, the proximity of interest rates to the ELB has become the preeminent monetary policy challenge of our time, tainting all manner of issues with ELB risk and imbuing many old challenges with greater significance.” In a matter of only a few months, Powell had turned from talking about raising interest rates to worrying about what the Fed would do once the federal funds rate was back down to zero!

Powell reiterated the Fed’s standing-by-to-ease status at his June 19 press conference, stating, “In light of increased uncertainties and muted inflation pressures, we now emphasize that the Committee will closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion, with a strong labor market and inflation near its 2 percent objective.”153 In the June FOMC statement, the “appropriate” phrase replaced the “patient” phrase.154

Powell also omitted another word from his June press conference that had made headlines following his May press conference. In May, he argued that recent low inflation readings were likely “transient.” But during his June press conference, he didn’t mention it again.

During the June FOMC meeting, Powell encountered his first dissenting vote since becoming Fed chair, from James Bullard, the loquacious president of the Federal Reserve Bank of St. Louis, who argued for a rate cut at that meeting. What’s more, eight Fed officials were now forecasting a rate cut in the coming year, according to the SEP.

On Wednesday, July 10 and Thursday, July 11, 2019, Powell presented the Fed’s semiannual testimony on monetary policy to two congressional committees.155 On Wednesday, he implied that he was ready to cut the federal funds rate at the next FOMC meeting at the end of the month. He was more emphatic about it on Thursday during his Q&A before a Senate committee.

In his prepared remarks on Wednesday, Powell emphasized his concern that uncertainty about trade negotiations between the US and China might be depressing the global economy and weighing on the US economic outlook. He mentioned the trade issue no less than eight times. Here’s one example: “However, inflation has been running below the Federal Open Market Committee’s (FOMC) symmetric 2 percent objective, and crosscurrents, such as trade tensions and concerns about global growth, have been weighing on economic activity and the outlook.”

On Thursday, Powell told the Senate Banking Committee, “The relationship between unemployment and inflation became weak” about 20 years ago, and “[i]t’s become weaker and weaker and weaker.” He also told the senators that the so-called “neutral rate,” or policy rate that keeps the economy on an even keel, is lower than past estimates have put it—meaning monetary policy had been too restrictive. “We’re learning that interest rates— that the neutral interest rate—is lower than we had thought, and I think we’re learning that the natural rate of unemployment is lower than we thought,” he said. “So monetary policy hasn’t been as accommodative as we had thought.”

In a July 16 speech, at a conference organized by the Banque de France, Powell stated: “Many FOMC participants judged at the time of our most recent meeting in June that the combination of these factors strengthens the case for a somewhat more accommodative stance of policy.”156

Two days later, on July 18, two of Powell’s colleagues weighed in with comments that seemed to telegraph increased odds of a federal funds rate cut at the next FOMC meeting at the end of July—Federal Reserve Bank of New York President John Williams and Federal Reserve Vice Chairman Richard Clarida.

In a speech titled “Living Life Near the ZLB,” Williams argued that monetary policy should be eased more preemptively and aggressively the closer that the federal funds rate is to the ZLB. He said that, based on simulation models, “monetary policy can mitigate the effects of the ZLB.”157 He mentioned three ways it can do so:

"The first: don’t keep your powder dry—that is, move more quickly to add monetary stimulus than you otherwise might. When the ZLB is nowhere in view, one can afford to move slowly and take a “wait and see” approach to gain additional clarity about potentially adverse economic developments. But not when interest rates are in the vicinity of the ZLB. In that case, you want to do the opposite, and vaccinate against further ills. When you only have so much stimulus at your disposal, it pays to act quickly to lower rates at the first sign of economic distress."

His second recommendation was “to keep interest rates lower for longer” to lower bond yields, resulting in “more favorable financial conditions overall,” which “will allow the stimulus to pick up steam, support economic growth over the medium term, and allow inflation to rise.” Finally, he promoted “policies that promise temporarily higher inflation following ZLB episodes.” He observed, “In model simulations, these ‘make-up’ strategies can mitigate nearly all of the adverse effects of the ZLB.”

Williams ended his speech by saying that the actions he recommended “should vaccinate the economy and protect it from the more insidious disease of too low inflation.” In my opinion, comparing near-zero inflation to an insidious disease is bizarre.

Williams’ public relations department rushed to set the record straight with The Wall Street Journal, which reported after the market’s close on July 18:

"New York Fed President John Williams didn’t intend to suggest Thursday that the central bank might make a large interest rate cut this month, a spokesman said Thursday. In the speech, presented at an academic conference in New York, Mr. Williams said policy makers needed to confront potential weaknesses more quickly given the prospect that a historically low interest rate could fall to zero sooner, leaving less room to stimulate growth in a downturn."

That same day, July 18, in a Fox Business Network interview, Clarida said that the economy is in a “good place.” Yet he alluded to “uncertainties” that might weaken the economy. He concluded, “You don’t need to wait until things get so bad to have a dramatic series of rate cuts.” He added, “We need to make a decision based on where we think the economy may be heading and, importantly, where the risks to the economy are lined up.”158

By the way, in his speech in Paris, Powell lamented that being a central banker is tougher than it was during Greenspan’s days at the Fed:

"It is challenging, because we are operating in a changing macroeconomic environment with tools that, while no longer new, remain less familiar to the public. Moreover, our audience has become more varied, more attuned to our actions, and less trusting of public institutions. Gone are the days when the Federal Reserve Chair could joke, as my predecessor Alan Greenspan did, “If I turn out to be particularly clear, you’ve probably misunderstood what I said.” Central banks must speak to Main Street, as well as Wall Street, in ways we have not in the past, and Main Street is listening and engaged."159

__________

This is an excerpt from my 2020 book, Fed Watching for Fun & Profit. Also see my 2021 book with Melissa Tagg, The Fed and the Great Virus Crisis.

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