The turbulence poses a direct challenge to Powell, who already steered the Fed through the devastation of the coronavirus recession. Now, Powell is expected to enter a second term leading the Fed, tasked with clamping down on inflation and withdrawing economic supports — without cutting off the recovery. The test is a delicate one, carrying enormous consequences.
Testifying before the Senate Banking Committee on Tuesday, Powell said it was essential to get prices down to more sustainable and stable levels to ensure a lasting recovery.
“If inflation does become too persistent, if these high levels of inflation become too entrenched in the economy or people’s thinking, that will lead to much tighter monetary policy from us and that could lead to a recession and that would be bad for workers,” Powell told lawmakers.
In November, prices rose 6.8 percent over the same period a year ago, and economists expect the December figure will be even higher when it is released by the Bureau of Labor Statistics on Wednesday. Powell said vaccination rates, combined with smoother supply chains, will help bring down inflation. But he said “the question is how fast?” especially since inflation expectations, which are often self-fulfilling, can morph in the meantime, which is dangerous territory for the Fed.
Fed leaders have projected at least three interest rate hikes this year and a rapid end to the Fed’s other support for the markets. The Fed will also have to make decisions about when to pare back its roughly $9 trillion balance sheet, with Powell acknowledging that “it’s far above where it needs to be.”
“The economy no longer needs or wants the very highly accommodative policies we’ve had in place to deal with the pandemic and the aftermath,” Powell said. “We’re really going to be moving over the course of this year to a policy that’s closer to normal. But it’s a long road to normal.”
Heading into the midterms, Republicans are poised to hammer Democrats on inflation, arguing that the sprawling stimulus measures from earlier in the pandemic overheated the economy and caused pain at the checkout line for households nationwide.
Republicans have also slammed the Fed, saying policymakers are behind the curve when it comes to reining in high prices. Their argument is that once the Fed steps in to raise interest rates and cool down the economy, they will be hard-pressed to do so without slamming on the brakes and causing a recession.
“I’m relieved the Fed has acknowledged inflation is running well above and longer than its initial projections,” Sen. Patrick J. Toomey (R-Pa.), the top Republican on the Banking Committee, told Powell Tuesday morning. “But I remain concerned with the Fed’s actions going forward.”
Democrats, meanwhile, have warned the Fed against declaring victory too quickly. Their concern is that the Fed will raise rates before some of the most vulnerable workers — including service-sector workers, workers of color and women — are back in stable jobs.
“When people talk about ‘cooling off’ the economy, what they really mean is making it harder for people to find jobs and stopping paychecks from growing,” said Sen. Sherrod Brown (D-Ohio), who chairs the banking panel. “And we know how this goes — the 'cooling off’ never seems to extend to corporate profits or executives’ pay.”
For much of the pandemic, the Fed said it wouldn’t step in to combat inflation because it believed rising prices were temporary, or “transitory,” and limited to parts of the economy affected most by the pandemic. Yet, as the months wore on, that prediction bore less resemblance to what was actually unfolding in the economy and the ways households experienced steeper rental prices or higher costs for gas and groceries.
When Fed leaders last convened, in December, they made their strongest move yet to tackle inflation, moving up the timeline for what could be as many as three rate increases this year. Fed leaders also sped up the pace by which they are drawing down the vast asset purchase program, to be better prepared to raise interest rates, possibly as early as March.
Part of the reason behind the Fed’s pivot is that the job market has made massive gains since the economy shut down in the spring of 2020. In December, the unemployment rate fell to 3.9 percent — not too far from the 50-year-low of 3.5 percent from February 2020. And while the December jobs report fell far short of economists expectations, Fed leaders are encouraged by the trend from much of 2021.
“We’re very rapidly approaching or at maximum employment," Powell said.
Powell’s renomination comes amid major personnel changes within the Fed’s top ranks. On Monday, the Fed’s second-in-command, Vice Chair Richard Clarida, announced he was resigning this week over questionable financial trades made at the beginning of the pandemic. Clarida is the third high-ranking Fed official to resign in recent months over stock trading, which prompted an overhaul of the Fed’s ethics rules and an independent inspector general probe. Sen. Elizabeth Warren (D-Mass.), who opposes Powell’s renomination, has pressed the Fed to release more information about the trades under scrutiny by next week.
In addition to renominating Powell for a second term, Biden is slowly filling in his slate of Fed nominees. In November, Biden tapped Fed governor Lael Brainard to be the Fed’s vice chair. Brainard’s confirmation hearing before the Senate Banking Committee will take place Thursday.
The White House is also closing in on three remaining nominations to the Fed board, and the administration is strongly considering Sarah Bloom Raskin, Lisa Cook and Philip Jefferson to complete the slate. Biden initially said those announcements would start early last month. It’s unclear when the nominees will be formally announced or how long it will take for them to be confirmed.