Buzz is growing about how the Fed’s promised new monetary-policy construct will do better than the old, failed FAIT. Last week, Chair Powell offered a teaser, the august Group of Thirty told it what to do, and former Chair Bernanke told the Fed how to tell all about it. Let’s hope the Fed indeed does better this time, but even if it does, Congress might well block the Fed from doing what it comes to think it must. When the Fed releases its new plan in the rarefied precincts of Jackson Hole this August, it’s likely to disregard what a very skeptical Congress thinks about it, let alone what might then be done to it either on the Hill or by Mr. Powell’s successor. Early warning signals show it will be a lot.
The Fed knows it’s at considerable political risk, but not all the ways political risk could strike it down. Mr. Powell is of course keenly aware that President Trump thinks he’s “Mr. Too Late, a major loser.” Anticipating still more political push-back, Mr. Powell tried to protect the Fed via a switcheroo early after the election, pulling the Fed back from climate-risk efforts and anything that smacks of reputational-risk supervision. That may help, but the Fed has yet to reckon with how much Members of Congress want a complete monetary-policy reset forcing the Fed to rely on open-market operations as the principal mechanism of monetary-policy transmission. Any new Fed policy construct that doesn’t shrink the portfolio, continues to rely on interest on reserve balances (IORB), preserves the Overnight Reverse-Repo Program (ONRRP), or eases up on inflation targeting will get a very, very rough reception.
Last week brought two sharp reminders that key Members of Congress contemplate wholesale, structural change in Fed monetary-policy operations. Some aspects of various proposals would have sweeping, adverse impact on the Fed’s ability to do much of what it might like, but Congress – in sharp contrast to the President – has the right to and privilege of telling the Fed how best to conduct itself. It did so first in 1913 in setting up the central bank, again in the 1930s, in 1946, in 1977 and 1978 when the Fed’s mandate was prescribed, and in 2010 via Dodd-Frank’s demand for lots more Fed transparency. If Congress now wants a different Fed, it gets to have one.
And what might it want? For starters, look hard at three bills introduced a week or so ago by Sen. Rick Scott, the Florida Republican said to be particularly close to President Trump. As FedFin’s in-depth analysis details, Sen. Scott wants to shrink IORB by two-thirds, shutter the ONRRP, prevent the Fed from monetizing U.S. debt, and give Congress the right to revoke quantitative easing (QE) or tightening (QT) along with any Fed emergency-liquidity facilities.
Interestingly, the Scott bill also gives the Fed a new mandate: protect the middle class. Sen. Warren will surely lead Democrats in supporting this proposal along with most of the rest of the Scott bill if it advances at a time when broader political animosities do not overwhelm any possible bipartisan initiatives in the Senate. Don’t wait up.
Sen. Scott is not alone among senior Republicans. House Financial Services Chair Hill last week closely questioned why the Fed holds so large and diverse a portfolio as well as why it pays interest on reserves. Mr. Hill raised these points at a hearing looking hard at how to ensure Treasury-market stability. One of the Fed’s answers will surely be that it needs to hold “ample reserves” and pay IORB to get banks to hand them over. However, the Fed is going to have to make very clear what number it thinks ample, why it’s necessary is ample comes out in the anticipated $3 trillion range, and why all of its other market backstops will not suffice. Congress will demand clear answers because most Members are no longer willing to give the Fed the benefit of the doubt given that the central bank now costs taxpayers a lot of money and has squandered its monetary-policy credibility by a series of bad and sometimes politically-inconvenient calls. Democrats may defend Mr. Powell to attack Mr. Trump, but they’ll exert little political capital solely to block less-partisan demands for Fed structural reform – Democrats, like Republicans, know the Fed needs it.
Further, reform proposals along current lines don’t need enacted legislation to make a very big difference. Mr. Powell’s term as chair ends early next year. Whomever President Trump nominates to replace him can and I think surely will redesign monetary policy to accommodate much in the Republican agenda embodied in the Scott bill and Hill inquiry. The Federal Open Market Committee might reject an approach if it differs much from whatever comes down the mountain, but this is unlikely and, should it occur, Congress will quickly override the FOMC.
Thus, for all the already-transfixed attention on the new Powell paradigm, it won’t last more than a few months if it’s not attuned to what key Members demand or a new chair wants. One way or the other, the Fed will step back from being the “only game in town,” banks will need to find alternative revenue streams, MMFs will have to handle their own repo risk, and much, much else will be very, very different. New Fed thinking could allay these hard lessons, but new thinking is what the Fed does worst.