While the Brett M. Kavanaugh battle spatters mud on the judiciary, there is shockingly good news from another technocratic branch of government. Improbably, the Federal Reserve is surviving the Trump era with its integrity intact. Jerome H. Powell, the Fed chairman since February, is quietly emerging as a skilled Washington operator.
When President Trump nominated Powell for the job last year, this was not inevitable. The president had shown no regard for the independence of the Fed: He criticized it openly, breaking a bipartisan norm of restraint that had lasted for a quarter of a century. Indeed, Trump had signaled an appetite for escalating the fight, announcing a growth target of 4 percent per year, twice what Fed economists believe to be sustainable. Worse, at the time of Powell’s nomination, the Fed’s seven-member board included two Trump choices and three vacancies. If Trump wanted to break the Fed’s independence and force it to go for growth at the risk of inflation, he just had to pack those vacant seats with allies who would resist higher interest rates.
Fast-forward one year, and the Fed has not been subjugated. Trump and his administration continue to target unsustainably high growth, and they make no secret of their preference for low interest rates. But they have nominated respected mainstream economists to the vacancies on the Federal Reserve Board, depriving themselves of the means to turn their preference into policy. The Fed could still face meddling from Congress, which has periodically threatened to “audit” the central bank or otherwise bully it. But those congressional threats come mostly from the hard-money right. Not only will the midterm elections likely diminish the right’s power, but the loose-money White House would unite with the Fed in squashing any such legislation.
The new team around Powell is not merely respected; it seems likely to bolster his leadership. Richard Clarida, the Fed’s new vice chairman, got the job with Powell’s support. Nellie Liang, recently nominated to the last open board seat, worked closely with Powell when she was a top staff economist. Powell is also said to be close to John Williams, the new president of the powerful Federal Reserve Bank of New York.
Thus fortified, Powell is proceeding to raise interest rates methodically. This week he is expected to raise them to a range of between 2 and 2.25 percent, and the markets confidently expect him to tighten the vise over the next year, which would slow the economy significantly during the lead-up to the 2020 presidential election. Trump can harrumph as much as he pleases. If Powell has his colleagues on his side, he can ignore the president.
The next challenge for Powell is to navigate an economy that sometimes seems to want two different interest rates. Inflation is rising only gradually, warranting the measured tightening that Powell is delivering. But asset-price inflation — in the stock market, the real estate market and so forth — has been frothier, suggesting a case for raising interest rates more rapidly. Borrowing by companies is particularly exuberant. An unusually high share of corporate bonds is classed as risky by rating agencies, and the murkier hedge-fund lending market is unnervingly spirited. When growth slows, default rates will spike and some firms will go bust. Hence the risk that the economy will not merely falter; it could go into recession.
Powell has taken the first step in solving this dilemma. Instead of making Wall Street feel safer by projecting confidence in the Federal Reserve’s model and promising to move interest rates in lockstep with its signals, he humbly proclaims uncertainty and discretion. Powell’s next move should be to match words with action by raising interest rates on a less-predictable schedule. Right now, market watchers are nearly unanimous in the view that the next rate increase will come in December. Whatever the correct level of interest rates at the end of the current tightening cycle, why not shake market complacency by getting there in a less obvious fashion? Shocking Wall Street now, when growth is robust, may prevent Wall Street from shocking the economy later, when growth will be fragile.
Finally, Powell should use his political skills to prepare for the next panic. As veterans of the 2008 financial meltdown have recently stressed, Congress has banned some of the bailout tools that proved essential last time. For example, the Fed cannot act as a lender of last resort for non-bank lenders unless they are already failing, the financial system is at risk and the Fed can show that no private rescuer is willing to step in — conditions that would guarantee slow action in a crisis. If Powell can persuade the administration and Congress to restore its bailout powers, he will not merely have upheld the Fed’s independence. He will have strengthened it.