Five questions for Federal Reserve Chairman Jerome Powell

First published by The Hill

Federal Reserve Chairman Jerome Powell has been criticized for taking seriously and then failing to respond to recent high levels of price inflation in the US. The FOMC may have finally changed its stance by raising interest rates by 0.75 percentage point at its June meeting. But many questions remain about the Fed’s policy and plans to tackle inflation.

The Federal Open Market Committee (FOMC) usually meets eight times a year to determine the position of monetary policy. After each meeting, President Powell holds a press conference where he receives questions from the media. Most reporters ask about the state of inflation or the Federal Reserve’s decisions on interest rates, while important policy questions go unquestioned.

Here are five important questions that will help the public better understand the Federal Reserve’s monetary policy.

1. What is the federal inflation target for 2022?

Before the pandemic, the FOMC had a stated goal of 2 percent annual inflation. In August 2020, the Federal Open Market Committee announced a new policy to target average inflation (AIT).

Powell explained that this new system aims to achieve an inflation rate of 2 percent over time. He gave an example that “when the rate of inflation falls below 2 per cent, the appropriate monetary policy is likely to aim for moderate inflation above 2 per cent for some time”.

This language seems to suggest that the opposite will also be true: that when inflation exceeds 2 percent, the Fed aims for moderate inflation below 2 percent in the future for an average of 2 percent over time. However, Powell has since made clear that this is not the case. “There is nothing in our framework about inflation falling below 2 percent,” he said. In other words, AIT is not a symmetric policy.

Under asymmetric AIT, the Fed promises to compensate for periods when inflation falls below the long-term target. And it makes no such promises for periods when inflation rises above the long-term target, as it has over the past 15 months. Compared with symmetric AIT, it is difficult to predict the future price level under asymmetric AIT.

Given this uncertainty, it seems fair to ask: What are the FOMC’s short- and medium-term inflation goals, and does Powell expect to achieve those goals?

2. How can asymmetric average inflation target anchor expectations?

When the Fed adopted AIT, it said the new policy would help “stabilize long-term inflation expectations.” But politics, as Powell made clear, does not appear to be consistent with this goal.

While a symmetric AIT may help stabilize inflation expectations, an asymmetric AIT risks inflation expectations becoming unconstrained. There are no clear short to medium term expectations when inflation will be above target.

Powell recently acknowledged that “a prolonged period of high inflation can push long-term expectations uncomfortably higher”. Does he still think AIT policy is useful in stabilizing inflation expectations? If so, how does he think it works?

3. Does money cause inflation?

Milton Friedman famously argued that “inflation is always and everywhere a monetary phenomenon in the sense that it can only be produced by increasing the quantity of money faster than output.”

It seems that President Powell does not agree with this view. In his recent testimony, he said that “there was a time when monetary policy aggregates were important determinants of inflation and this has not been the case for long”. He further explained, “The relationship between […] M2 and inflation is very, very low.”

It is not entirely clear what Powell meant by this. It mentions both M2 and ‘Monetary Policy Aggregates’. The relationship between simple sum measures such as M2 and inflation is weak. However, research by Joshua Hendrickson shows that the most favorable measures of money (that is, Divisia cash totals) are causally related to nominal spending and price level.

Powell should be urged to make his point clear. Does it deny the existence of a causal relationship between money growth and inflation? Or does he just think that money is not the only possible cause of inflation. Perhaps he thinks that excessive growth of money is not the cause of inflation in this particular case, attributing price hikes to supply disruptions instead. Whatever the case, it should be clear.

4. What role does the IOR play in monetary policy?

In 2008, when the Fed initiated quantitative easing (QE) and began paying interest on reserves (IOR) that banks hold at the Fed, it shifted its monetary framework from a corridor system to a floor system. Given this change, some Fed economists say the IOR rate, along with the overnight reverse repurchase agreement rate (ONRRPs), is the “main tool” of monetary policy.

But it seems that President Powell does not agree with this view. Discusses IORs and ONRRPs only as an afterthought or when specifically asked about them. Even so, it only refers to it as a “technical adjustment” to the interest rates administered by the Fed.

Given the stark contrast between his statements and those of federal economists, it seems worth questioning what role Powell believes the IOR rate and ONRRPs play in the Fed’s monetary policy.

5. Will the Fed pull out of the net to green the financial system?

The Federal Reserve recently took on a new role in climate policy. Powell says that the Fed’s role is limited to assessing climate-related risks to the financial system and that it should not set out broader economic policy related to climate change.

However, since 2020, the Federal Reserve has been a member of the Network for Greening the Financial System (NGFS). The stated purpose of this organization is to “mobilize mainstream financing to support the transition towards a sustainable economy”. More specifically, it aims to “mobilize capital for green and low-carbon investments.”

Powell says the Fed is not interested in allocating credit, but the purpose of the NGFS is to direct credit toward green, low-carbon investments. Will Powell commit to withdrawing the Fed’s membership of the NGFS?

These are important questions that President Powell must answer. But first, questions must be asked.

Thomas L. Hogan

Thomas L.  Hogan

Thomas L. Hogan, Ph.D., is a senior faculty member at AIER. He was previously the chief economist for the US Senate Committee on Banking, Housing, and Urban Affairs. He has also worked for Rice University’s Baker Institute for Public Policy, Troy University, West Texas A&M University, the Cato Institute, the World Bank, Merrill Lynch Commodity Trading Group, and for investment firms in the United States and Europe.

Dr. Hogan’s research has been published in academic journals such as Macroeconomics Journal and the Journal of Money, Credit and Banking. He has appeared on programs such as BBC World News, Stossel TV and Bloomberg Radio and has been cited by media outlets including CNN Business, American Banker and National Review.

Selected Publications

“Bank Lending and Interest on Excess Reserves: An Empirical Investigation,” Macroeconomics Journal, Coming, express, appears.

“Calculating the Opposition: Bias and Diversity in FOMC Expectations,” general option 19: 105-135 (2022).

“Hayek, Cassel, and the Origins of the Great Depression” (with Lawrence H. White) Journal of Economic Behavior and Organization181: 241-251 (2021).

“Did Dodd-Frank Affect Bank Expenditures?” (with Scott Burns) Journal of Organizational Economics55 (2): 214–236 (2019).

“Ben Bernanke and Bagehot Rules” (with Lynne Law and Alexander William Salter) Journal of Money, Credit and Banking 47(2-3): 333-348 (2015).

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