BNP Paribas AM: Five topics for Chairman Powell

On 1st March, Jerome Powell, the new Chairman of the Federal Reserve, will appear before a hearing of the Senate Banking Committee to present the semiannual Monetary Policy Report. While a Governor, Powell increasingly played a lead role on regulatory policy, but when it came to monetary policy he largely stuck to Janet Yellen’s script. As such, despite the reasonable assumption that Powell represents continuity with Yellen, there are still a number of areas where greater clarity from the Chairman will improve the public’s understanding of how he views the workings of the economy and the likely evolution of monetary policy. The timing of the testimony is particularly fortunate, given uncertainty over how the new Chairman will incorporate significant fiscal stimulus into the policy outlook when the economy is already at full employment and operating at an above-trend rate of growth. In the spirit of eliciting clarity from the Chairman on these and other key issues, this brief note suggests several questions that members of Congress should consider posing in the course of the hearing.

Improving transparency and communications.

In your prepared remarks at your swearing-in ceremony, you noted that the Federal Reserve will, “continue to pursue ways to improve transparency both in monetary policy and in regulation.” Are there specific improvements on the policy front that you have in mind? For example, are you in favor of publishing a policy rule that would capture the Federal Open Market Committee’s reaction function and serve as a basis for discussing recent and anticipated policy adjustments? Do you believe that publishing a rule of the Committee’s own choosing would improve or hinder the Federal Reserve’s communications with the public and its independence from politics? In addition, are you contemplating any changes to the frequency of post-meeting press briefings? Finally, do you see other ways to enhance communications around the economic and policy outlook, for example by introducing improvements to the quarterly Summary of Economic Projections?

Fighting the next recession.

Your views on central bank asset purchases appear to have evolved over time. The transcript of the September 2012 FOMC meeting indicates that you supported the third round of asset purchases but with “a certain lack of enthusiasm.” In a mid-2013 speech you described the evidence on the effectiveness of asset purchases as “mixed, but positive on balance.” However by 2015, you commented, “the evidence so far is clear that the benefits of these policies have been substantial, and that the risks have not materialized.” In the next recession, even if a mild one, the Committee may again find it necessary to provide additional stimulus even after cutting the policy rate to close to zero. In such a scenario, would you be comfortable resorting to asset purchases, or do you continue to have some reservations about their effectiveness? Does your comfort level change if this scenario were to play out relatively soon, that is, well before the Federal Reserve has completed running off assets purchased during prior rounds of quantitative easing? In addition, are you equally comfortable buying both Treasuries and agency mortgage-back securities, or are there scenarios where purchasing one over the other would be preferable? Finally, if you see constraints in using asset purchases in the next recession, are there other tools you would use to compensate, such as cutting the target for the federal funds rate to below zero or using forward guidance?

Changing the policy framework.

Related to the above issue, over the past year or so a number of current and former Federal Reserve officials have urged consideration of possible changes to the Committee’s longer-run policy framework. These changes are aimed at creating additional space to ease financial conditions in a future recession, when the policy rate is very likely to be back at the zero lower bound and the Committee may face serious constraints in cutting real interest rates. Proposals for a framework change include a higher inflation objective or a move to price level or nominal GDP targeting. Is studying the adequacy of the framework and examining possible alternatives a priority for you, and if so, do you anticipate that the Committee will formally take up the issue this year? At this point, how do you view the strengths and weaknesses of some of the alternative frameworks that have been suggested?

Fiscal policy.

Much of the public’s focus on monetary policy over the medium term revolves around the Federal Reserve’s potential response to the recently enacted Tax Cuts and Jobs Act (TCJA). Do you believe some elements of the TCJA will have a notable and positive impact on trend growth, and if so, through what channels would this occur? If you do see some positive effects of the TCJA on the economy’s potential, would these elements suffice to offset over the next few years any inflationary impulse from the tax cuts and the recent two-year budget deal, which will increase discretionary spending by approximately $300 billion? Can you provide your estimates of how this new spending agreement will impact GDP growth, inflation and the labor market (as captured by the unemployment rate) through 2020?

Balance sheet policy.

The normalization of the Federal Reserve’s balance sheet has been described as being on “auto pilot”. For example, the wording of the June 2016 addendum to the policy normalization plan suggests that run-off will continue until the Committee finds itself significantly cutting the policy rate in a recessionary environment. Can you envision any circumstances under which balance sheet runoff could halt even as the expansion continues, for example if downside risks to the outlook increased? Would you be comfortable continuing with balance sheet runoff even if financial conditions tighten significantly due to a substantial spike in long-term interest rates, perhaps tied to increased issuance to fund tax cuts and new spending?