As prominent economists, Republican lawmakers and some market analysts raise alarm bells about the risks of overspending and overstimulating the economy, the Biden administration has found a surprising ally: the Federal Reserve.
Federal Reserve Chair Jerome H. Powell is waving off concerns about an over-torqued economy producing long-feared inflation, saying the job market has a long way to heal before such fears are justified. In recent weeks, the position has been repeatedly embraced and cited by top Biden officials who make a similar argument when they say Congress needs to “go big” to ensure an economic revival.
As a result, the Fed and the White House appear closely aligned on policy — which can be a risky place for the central bank. With Powell at the Fed, and his predecessor Janet Yellen serving as treasury secretary, neither power center regards the potential dangers of overspending as a top concern.
If this view is right, the economy could be in for a Goldilocks period of strong growth, low unemployment and rising wages. But critics argue that if the Fed and the White House turn out to be wrong, it could lead to a cycle of rising prices, higher interest rates and a national debt that is harder to manage.
Indeed, bond yields and interest rates jumped last week as markets assessed that it is likelier that the economy will be far stronger in coming months.
“They all think alike,” said Douglas Holtz-Eakin, former head of the Congressional Budget Office and now the president of the American Action Forum, a center-right think tank, of the Fed and the White House. “They’re just working off the same playbook.”
The situation is tricky ground for the Fed, which has spent decades professing its independence from politics and as a guardian against inflation. Former Fed chair Paul Volcker famously acted to stem spiraling inflation in the late 1970s and early 1980s, causing a recession but making clear that the central bank would always act to keep prices from rising too fast. That has stood as a bedrock of economic policy for nearly 40 years.
In 2019, Powell stood firm against attacks by President Donald Trump, who criticized him routinely for not doing more to stimulate the economy, labeling him an “enemy.” No one is accusing the current White House of exerting similar pressure. But Powell appears cognizant that he must tread carefully in what he says about stimulus funding, given Democrats’ willingness to cite his arguments.
Powell, for example, has staunchly refused to weigh in on the particulars of Biden’s stimulus package and has been quieter about the need for stimulus funding more generally. That’s a notable shift from 2020, when he pushed hard for more fiscal aid and it was unclear whether a Republican Congress or Trump White House would approve another bill.
Still, in recent remarks, Powell has repeatedly laid the economic groundwork for more spending, making clear he doesn’t see big risks to additional action. It’s possible that there could be “some upward pressure on prices,” Powell said this month, but his “expectation is that will be neither large nor sustained.”
“Inflation dynamics do change over time, but they don’t change on a dime, and so we don’t really see how a burst of fiscal support or spending, that doesn’t last for many years would actually change those inflation dynamics,” Powell said last week before the Senate Banking Committee.
Over two days of hearings on Capitol Hill last week, Powell turned down questions from Republican and Democrats about whether the federal minimum wage should be raised to $15 an hour, or what the central bank thinks about affordable housing, broadband access, unemployment insurance or the total price tag of Biden’s package.
“Let me say, as I must, that this is a classic issue the Fed never takes a position on. And I’m not going to take a position on here today,” Powell said in response to a question from Sen. Tim Scott (R-S.C.) on whether Democrats’ push to raise the minimum wage would hurt the economy.
Powell’s remarks about the room for additional stimulus funding have been fodder for Democrats.
For example, after Powell told lawmakers last week that there is a long way to go on the recovery, Biden economic adviser Jared Bernstein tweeted Powell’s remarks and added: “The Rescue Plan gets us there.” Bernstein noted the bill’s proposed funding for vaccinations, state and local governments, business relief, a $15 minimum wage and schools.
In another instance, Powell said a more accurate measure of the unemployment rate is close to 10 percent, not the official rate of 6.3 percent. White House Chief of Staff Ron Klain pointed to the comments and tweeted: “The danger is not in doing too much. The danger is in doing too little.”
At a news conference this month, House Speaker Nancy Pelosi (D-Calif.) said Biden’s “legislation is necessary, but don’t take my word for it.” She then mentioned Powell’s 10 percent figure, his lack of concern about inflation and his reminders that monetary policy can’t finish the recovery alone.
When asked recently about the risk of inflation, Yellen said the Fed could step in, if need be.
“Inflation has been very low for over a decade. And, you know, it’s a risk, but it’s a risk that the Federal Reserve and others have tools to address,” she told CNBC this month.
Some see the similar messaging between the Fed and Biden administration as intentional.
“[Powell] knows as well as anybody that his former colleague Janet Yellen is pushing for this massive 1.9 trillion spending plan,” said Tim Duy, an economist at SGH Macro Advisors and the University of Oregon. “So I find it hard to see this as anything but a concerted effort between the two agencies, between monetary and fiscal policy, to send the economy into the stratosphere.”
At the same time, the Fed and Treasury Department have a long history of close collaboration, particularly in a crisis. Powell worked well with Trump’s treasury secretary, Steven Mnuchin, despite a public clash late last year over emergency lending programs propped up through the Cares Act.
If anything, many economists say Yellen would be the last person to cross boundaries on Fed independence after her lengthy career at the Fed.
“Janet Yellen and Jay Powell will have a relationship of deep mutual respect and will fundamentally agree about the objectives their two organizations are charged with pursuing,” said David Wilcox, former director of Division of Research and Statistics at the Fed. “But respect for one another and agreement about objectives will not preclude their having vigorous conversations about all the complex questions involved in any important policy decision.”
The stimulus debate is just one example of a broader tug-of-war between Republicans and Democrats over what they want the Fed to be. As part of December stimulus negotiations, Sen. Patrick J. Toomey (R-Pa.) led a charge to limit the Fed’s emergency lending authority, fearful of political influence.
“My concern was there would be tremendous political pressure to misuse these,” Toomey said at the time. Toomey has also expressed concerns about the Fed’s more public engagement on tackling issues such as racial equity and climate change.
Now the inflation question has added a new, fraught dimension to stimulus talks.
A number of economists and lawmakers say Biden’s bill goes overboard and could actually overwhelm the economy. Harvard professor Larry Summers, who was President Bill Clinton’s treasury secretary and nearly picked by President Barack Obama to lead the Fed, raised alarms this month when he wrote that a big stimulus package could “set off inflationary pressures of a kind we have not seen in a generation.”
His concerns have been echoed by Olivier Blanchard, a former top economist at the International Monetary Fund, who has written that the “increase in inflation could be much stronger” than many economists expect.
Some Republicans agree. In a hearing this month, Toomey told Powell that there is “a real danger that we have overheating in places that lead to unwanted inflation, and I think the data is increasingly pointing in that direction.”
“The last thing we need is a massive multitrillion-dollar universal spending bill, and we should recognize that all of this spending comes at a cost,” Toomey said.
Skeptics such as Summers cite recent research that suggests $1.9 trillion in new federal spending this year would more than close the gap between where the economy is running and what its potential could be. Going far above that could lead to inflation, a problem the country hasn’t seriously experienced since the 1980s.
Heavy inflation, in turn, could force the Fed to raise interest rates, which would crimp economic growth and also raise the cost of servicing the growing national debt.
But the concern is far from universal among economists, including Yellen and Powell, whose shared view is shaped at least in part by changing perspectives at the central bank.
In the years that followed the Great Recession, the unemployment rate continued to fall without triggering a rise in inflation. That challenged the Fed’s traditional understanding of the trade-off between inflation and maximum employment.
In August, the Fed unveiled a new framework that essentially said it wouldn’t raise interest rates to respond to low unemployment. In turn, the Fed will let the economy run hotter for longer and even tolerate temporary inflation above its 2 percent annual target.
“This change may appear subtle, but it reflects our view that a robust job market can be sustained without causing an outbreak of inflation,” Powell said at the time.
The White House and Powell are banking on the idea that any rise in prices this year would be limited to certain pockets of the economy and wouldn’t translate into persistent, widespread inflation or asset bubbles. They also emphasized the 10 million Americans whose jobs have still not returned, as well as the pressing need to get the pandemic under control.
“I have spent many years studying inflation and worrying about inflation,” Yellen told CNN this month. “But we face a huge economic challenge here and tremendous suffering in the country. We have got to address that. That’s the biggest risk.”
Adam Posen, president of the Peterson Institute for International Economics, said much of the inflation debate depends on how much economists are “carrying the scars of the 1970s and 1980s with you when you think about monetary policy.” The Fed’s thinking, Posen said, has been shaped by years of looking closely at changes in the actual economy that did little to set off inflation.
“In policy, there’s always a thousand reasons why there’s a policy shift,” Posen said. “This from Powell and the Fed should not be seen as some political caving or some momentary whim. This is the cumulation of a lot of evidence, and evidence not just in the academic sense, but of what we’ve lived through for the last 25 years, here and in a number of countries.”
Still, the Fed’s model could soon be tested to an extraordinary degree.
If Powell is wrong, “the Fed could quickly wake up one day and come to feel they’re behind the curve,” said Michael Strain of the American Enterprise Institute, a right-leaning think tank. Strain says the likelier scenario is that inflation grows to levels the Fed is comfortable with, but then spikes every few months until the upward creep is cause for concern.
Strain said there isn’t an inherent problem with the Biden administration and Fed agreeing on policy. The risk Strain sees is if they are agreeing — “and not appropriately balancing all the risks in this situation. And so that’s what I think we have there.”
“Then the Fed has a huge communications problem because they’ve signaled so much comfort with inflation and with the economy’s capacity to absorb the fiscal stimulus,” he added.
Still, Joe Brusuelas, chief economist at RSM, shot down arguments around “group think.” Brusuelas said the Fed and Treasury are full of economists with a range of opinions and rigorous research. He noted that Powell is a Republican made chair under Trump, while Yellen is a Democrat in Biden’s White House.
“Anybody who has read Powell’s speeches, or Yellen’s speeches, or Yellen’s academic work will tell you they do not share the same thoughts on all topics,” Brusuelas said, “even if right now they have the same broad analytical framework about the way policy should proceed.”