NEW YORK, March 28 (Reuters Breakingviews) - As of early February, Joe Biden had never phoned up Jerome Powell. Yet the U.S. President’s bid to win a second term next year resides, in part, on how the chair of the U.S. Federal Reserve deals with high inflation and a banking crisis. As former President Donald Trump will attest, Powell will do what he thinks it’s right. But that may not stop Biden wishing he could push the Fed to do what’s politically expedient, especially given the economic predicament Powell is in.
Up until March 10, Powell’s priorities had been starkly clear. After reacting slowly to a surge in inflation in 2021, the Fed was now laser-focused on slaying rampant consumer prices. Powell had sanctioned a rapid and aggressive series of interest rates hikes in an effort to cool economic activity – a plan that, as he admitted, would bring “some pain to households and businesses."
As recently as March 7, Powell indicated he could raise rates even faster than previously thought. In congressional testimony, he suggested that the Fed funds rate could go up by 50 basis points later that month, surprising investors who had bet on an increase half that size.
Three days later, a run on deposits at Silicon Valley Bank, the 16th largest lender in the United States, led to its failure. The Fed and other agencies had to step in with a lending facility to boost liquidity for other banks and backstop any deposit beyond the $250,000 federally mandated level. Shortly after, the government shut down Signature Bank (SBNY.O) and cajoled big lenders into injecting deposits into First Republic Bank (FRC.N).
Those banking crises threw Powell’s anti-inflation plan into disarray by adding another front to his war against the U.S. economic malaise – ensuring financial stability. That is part of the Fed’s mandate, alongside keeping inflation low and employment high, but the central bank doesn’t have to do much when banks are healthy. SVB’s failure changed that.
The problem for Powell, the Fed and Biden, who faces a presidential election in November 2024, is that the central bank’s tasks are at odds with one another.
Backing the banks with liquidity injections increases the amount of money in circulation, pushing up inflation. That, in turn, dilutes the effect of the Fed’s drive to increase borrowing costs. Yet the recent shocks are likely to have scared banks into lending less, which would reinforce the chilling effects of monetary policy, increasing the danger the U.S. will tip into a recession this year. To make matters even more complicated, SVB failed because the sharp rise in interest rates caused losses in its bond portfolios, underlining the risk that further tightening could cause more banks to collapse.
At the center of this three-dimensional puzzle stands Jerome Powell, a 70-year-old former attorney and partner at Carlyle (CG.O), the private equity group. The circumstances have granted him tremendous powers to influence the course of the world’s biggest economy and the next presidential election but also commensurate responsibilities. His first move since the recent turmoil was a fudge – the Fed went for a quarter-point rate rise while saying it stands ready to support the banking sector.
History shows that economic conditions play an important part in how Americans vote. Bill Clinton's campaign strategist James Carville famously coined the term "it's the economy, stupid" when setting the direction of his running. Franklin D. Roosevelt campaigned on the idea that Americans should get a "new deal," which laid the foundation for his program to revive the economy. President Gerald Ford took office in 1974 but was defeated at the next election after a Fed policy to get inflation under control by raising rates led to increased unemployment. Jimmy Carter similarly served only a single term after his spending plans to boost economic activity led to rampant inflation.
Today, high unemployment is not an issue but that might not matter inside the polling booths next year. Research by Gerald Kramer in 1971, analyzing voting patterns dating back to 1896, found that economic growth, as measured by changes in real per capital income, was the major economic variable in voting, whereas unemployment and inflation had little effect. A 1992 paper titled “Peasants or Bankers” by three political scientists found that voters were more likely to “respond with little gratitude for past prosperity independent of future economic promise."
Biden’s Democratic party is acutely aware of that, and pressure on Powell is ramping up, albeit from those who were always reticent to support him. This month, Democratic Senator Elizabeth Warren, a left-wing firebrand, went on TV and called Powell a “dangerous man,” saying she doesn’t think that he should be Fed Chair. CNN television host Jake Tapper asked her if she had told Biden that Powell should be fired. Though Warren said she wouldn’t talk about private conversations, she reiterated that she thought he was doing a “really terrible job.”
Just last week Biden reiterated that he had confidence in Powell. “President Biden has repeatedly shown — in action and word — that he will ‘respect the Fed and respect the Fed’s independence.’ An independent Fed is key to the President’s top economic priority: fighting inflation,” according to a statement from a White House spokesperson. But past Presidents from Bill Clinton to George Bush to Donald Trump have publicly urged the Fed to make changes to policy.
In practice, it is extremely difficult for a president to fire the chair of an independent agency such as the Fed – and it has never happened. The next few months, though, could test the relationship between Biden and Powell.
The problem for both the Fed Chair and the President is that inflation isn’t going away. The consumer price index rose 6% in February from the year before. That was down from 6.4% in January and marked the eight consecutive monthly decline in the key price gauge. Yet inflation remains three times above the 2% target Powell is aiming for – an uncomfortable level that calls for further rate rises. The Fed’s own expectations are for at least one more quarter-point hike bringing the benchmark rate to a range of 5% to 5.25%.
That could cause problems for both banks and Biden’s re-election campaign, especially if the cumulative effects of Powell’s tightening campaign tip the economy into a recession. The Conference Board, a think tank, puts the odds of an economic contraction in the next 12 months at 99%.
Powell has been here before, with Biden’s predecessor. During his re-election campaign in late 2019, Donald Trump put pressure on the Fed to cut rates. Then Trump called Powell “a golfer who can’t putt, has no touch.” Trump wanted economic growth. Powell resisted and later responded saying that the Fed chair, more than anyone else, needs to be free from political pressures.
Biden has a different style, and his predecessor’s pushback may make it doubly hard to publicly question Powell. But if current banking and economic conditions force an abrupt change to the way Americans see their lot in life, Biden, too, may find it harder and harder to bite his tongue.
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