The future of the Federal Reserve

This week marked a significant moment in the history of the Federal Reserve as outgoing chair Jay Powell led what is likely to be his final meeting of the central bank’s rate-setting committee. Donald Trump’s pick to succeed Powell is expected to start on May 15 and chair his first meeting on June 16-17. Ahead of this historic change at the top of the Fed I asked Claire Jones, the FT’s US Economics Editor, a series of questions about what the transition will mean for the future direction of monetary policy in the US.

Gordon Smith: Hi Claire, thanks for agreeing to answer these questions for FirstFT readers. This week Jay Powell, the outgoing chair of the Federal Reserve, said he would remain as a governor “for a period of time” in a move that surprised many after chairing his final rate-setting meeting. How unusual is it to have a former Fed chair serving as a governor under a new chair?

Claire Jones: Jay Powell is the first chair since Marriner Eccles in 1948 to stay on as governor past the end of their term at the helm of the world’s most important central bank. In short, it’s pretty unusual. In terms of the threat to the central bank’s independence, however, one could argue these are unusual times.

GS: Kevin Warsh is expected to take over from Powell on May 15. How do you think Warsh’s leadership of the US central bank will differ from Powell’s? I’ve read he’s thinking of dropping completely or dialling back the number of press conferences Fed officials hold and possibly banning dot plots. Are there any other changes you expect the new chair to make in terms of the way he communicates with the markets?

CJ: Warsh’s overarching approach to communication is less is more. He wants to lead by example by making fewer speeches and giving fewer interviews, hoping the rest of the Federal Open Market Committee will follow suit. I doubt they will do so — at least not initially.

Warsh has also said he wants to see “family fights” at policy votes, where officials thrash out solutions only after vigorously debating all of the available options. Given that the most recent policy vote prompted four dissents — the most since 1992 — on this score, he may well get what he’s wished for.

GS: That should make for some interesting minutes. Moving on to Warsh’s relationship with Trump, do you think he will become the president’s “sock puppet”, in the words of Elizabeth Warren, and what are the economic challenges he faces as he prepares to take over at the helm of the US central bank?

CJ: No one can fully know how Warsh will respond to the culture within the Federal Reserve — and the pressure from the White House. My own best guess is that he won’t be a “sock puppet” and will instead likely disappoint Donald Trump by not cutting US interest rates as much as the US president desires.

The economic challenges are myriad. The Iran war has sent oil prices soaring; expect US inflation to follow suit in the coming months. The job market is not as strong as it once was either. Stagflation — the combination of higher prices and lower growth — is a central bank’s worst nightmare and a real risk.

GS: What do you make of Warsh’s claim that AI productivity gains could justify cutting interest rates? 

CJ: Within the Fed’s senior ranks the idea is not popular. At least not for now. 

Rate-setters agree with Warsh’s claim that AI will produce productivity gains that, over time, will probably enhance the US economy’s potential to grow at a faster clip without inflation. However, they argue that, in the short-run, AI is more likely to stoke inflation than mitigate it. The reason? AI-induced capital spending is impacting demand more than the technology’s use is impacting supply. 

GS: And can you tell us a little more about Warsh’s data project? He’s said he wants to survey a billion prices. Why? And what does this mean for inflation measurements in the US?

CJ: At the moment, the Fed’s 2 per cent inflation target is based on the headline personal consumption expenditures measure, though officials monitor many gauges of price pressures. Warsh has advocated switching to the trimmed mean measure, which strips out the most volatile price changes. Advocates say this prevents the figure from being skewed by massive, or tiny, changes in the price of some goods. 

However, shifting the target might be badly received at a time when inflation has eluded the Fed’s goal for more than five years and suspicions about Warsh’s commitment to the central bank’s independence abound. 

The Billion Prices Project was an idea dreamt up by economists at the Massachusetts Institute of Technology in 2008, but it is no longer active. It’s difficult to know how Warsh intends to revive it, but his nod to it suggests he may be keen for the Fed to play a more active role in producing inflation sets based on data scraping. 

Now, a reader question. Dave Rogers, from Vero Beach, Florida, asks why doesn’t the central bank . . . consider the extreme financial impact of interest rates on the middle and lower classes, over the banks?

CJ: The uneven impact of central banks’ actions is a genuinely important question that doesn’t always get the attention it deserves.

The Fed firmly believes it prioritises the interests of the American public over those of banks. The message Powell has often delivered, and Warsh will probably stick to, is that inflation hits the poorest Americans hardest. And by attempting to keep inflation in check, they believe they are acting in the long-term interest of the most vulnerable members of the public.

However, the main tool it uses to achieve low and stable price growth — moving interest rates up and down — is blunt, and the pain can never be evenly shared.

Before you go . . . 

Do you think Warsh will be Trump’s “sock puppet” and reduce interest rates in the early months of his tenure or will rising inflation mean he has to stay put for now? Have your say in our latest poll.