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Politics Biden should signal to the Fed that it's okay to raise rates next year

23:00  22 november  2021
23:00  22 november  2021 Source:   thehill.com

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With President Biden reportedly reappointing Jerome Powell to a second term as Federal Reserve chair and make Lael Brainard as vice chair, he will have an opportunity to meet with them privately. So why am I suggesting Biden should do what no other U.S. president has

Federal Reserve Chairman Jerome Powell is seen during a Senate Banking, Housing, and Urban Affairs Committee hearing to discuss oversight of the CARES Act within the Federal Reserve and Department of Treasury on Tuesday, September 28, 2021. © Greg Nash Federal Reserve Chairman Jerome Powell is seen during a Senate Banking, Housing, and Urban Affairs Committee hearing to discuss oversight of the CARES Act within the Federal Reserve and Department of Treasury on Tuesday, September 28, 2021.

done and indicate that he wants the Fed to raise rates in an election year?

To be sure, throughout the Fed's history, the opposite tack has been more common: Presidents Johnson, Nixon and, most recently, Trump all jawboned the Fed to keep interest

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rates low to support the economy and their reelection prospects. The prime exception is

Ronald Reagan. He inherited double-digit inflation and did not stand in the way of short-

term interest rates reaching 20 percent during Paul Volcker's tenure as Fed chair.

I base my argument on both economic and political considerations. First, the U.S. economy is well on the way to a full recovery from the COVID-19 pandemic. The Federal Reserve's latest projections call for GDP growth to be in the vicinity of 6 percent this year and 4 percent next year. The Fed also expects the unemployment rate, which has fallen to 4.6 percent in October from a peak of 15 percent last year, to drop below 4 percent next year, or nearly back to where it was before the pandemic.

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  Biden has a major economic decision to make and he can’t seem to pull the trigger The president spent decades in the Senate, where deliberation is viewed as a virtue. It shows.President Joe Biden has been wrestling for weeks with whether to reappoint the current Chair of the Federal Reserve, Jerome Powell, or replace him with Lael Brainard, a Democrat and economist who has served on the Fed board since 2014. The process has resembled a tortured morass of indecision. Forever the senator, Biden has engaged in an extended debate, soliciting opinions and facts far and wide as he looks to fill a vital post at a time of deep economic uncertainty and political peril.

Second, inflation has far exceeded the expectations of the Federal Reserve and many

Americans. Consumer price index (CPI) inflation in October reached a 31-year high of 6.2 percent and 4.6 percent ex food and energy, and the Fed has upped its estimate of core inflation this year to 3.7 percent, from 3.0 percent.

Labor market tightness is also evident in record job openings and quit rates, as well as

increases in unit labor costs. While wage pressures have been greatest for lower-paying

jobs, they may be spreading to large corporations. For example, the recent strike

settlement for John Deere workers granted employees 10 percent pay bumps, bonuses of

$8,500 and increased retirement benefits.

Third, this outcome is not only the result of supply-chain disruptions from the pandemic

that have contributed to a temporary spike in inflation. It is also the result of highly

expansionary policies.

According to Jason Furman, chair of the Council of Economic Advisors in the Obama

administration, "the oversized and poorly designed $2.7 trillion fiscal relief packages"

passed in December and March boosted aggregate demand when the economy already

was experiencing a strong recovery. They gave individuals checks from the federal

government of $2,000 each when many households had not fully spent the prior transfers

they received.

In addition, the Federal Reserve's accommodative monetary policy stance has

contributed to lower long-term rates, higher stock prices and other financial market

changes that bolstered the economy. Furman maintains the easy financial market conditions have been the equivalent of more than a one percentage point cut in the

federal-funds rate since the election in November 2020.

On the political front, public opinion polls show Biden's approval rating slipping since

midyear. This is due in part to the surge of the delta variant and the chaotic withdrawal

of U.S. troops from Afghanistan. But these polls also increasingly reflect the public's

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growing concern about inflation and the economy.

The NY Fed's survey for October, for example, showed households now expect CPI

inflation will be 5.7 percent in the next 12 months and will average 4.2 percent annually over the next three years. Moreover, consumer confidence as measured by the Michigan survey has failed to recover from the lows of the delta wave due in part to concerns about inflation.

In these circumstances, President Biden is now under pressure to do something to stem

inflation. He has argued that the bipartisan infrastructure bill that was recently enacted

and the pending legislation to tackle climate change and expand the social safety net will

help alleviate supply bottlenecks. However, few economists believe these programs will

have an impact on the economy and inflation in the short-medium term.

So, what can Biden do to rectify the situation?

Journalist Jeff Greenfield argues that the reality is that Biden, like his predecessors, is playing with "an empty inflation toolbox." The dilemma is that "Presidents have almost no power to ease the pain of inflation, and the voting public cuts

presidents no slack at all because of that impotence."

The job of tackling inflation of course resides with the Federal Reserve. Chair

Powell has indicated that the Fed is not contemplating raising interest rates before the

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tapering of its bond purchase program is completed in mid-2022. This means the first

opportunity for it to raise rates would be around the 2022 mid-term elections. If so, it may feel compelled to stay on the sidelines and defer acting until 2023.

In my view, time is of the essence. In a recent interview, Harvard economist Kenneth

Rogoff stated, "I think we're on a knife edge" of where inflation is going, calling the

latest readings "eye opening." The Fed has been able to maintain investor confidence thus

far because inflation has been low for the past two decades.

However, there are indications that inflation is creeping into Americans' psyches as it did in the late 1960s. Therefore, if inflation stays elevated, the Fed must be prepared to act without worrying about the political consequences. In the end, containing inflation would be positive for the economy's long-term outlook as well as for President Biden's reelection prospects.

Nicholas Sargen, Ph.D., is an economic consultant and is affiliated with the University of Virginia's Darden School of Business. He is the author of "Investing in the Trump Era; How Economic Policies Impact Financial Markets."

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