The Big Idea

Reshuffling the deck at the Fed

| July 23, 2021

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

The Federal Reserve is an independent agency, which means that board members serve out their terms without regard to changes in the presidency.  Nonetheless, new presidents inevitably get the chance to make their own appointments, as Fed governors tend to only serve on average for a few years, and openings regularly arise.  President Biden has a unique opportunity over the next six months or so to choose the entire Fed leadership, including the chair.

Fed board terms

There are several details regarding the terms of Federal Reserve governors that warrant discussion.  Governors serve 14-year terms, but when a governor resigns before his or her term expires, the replacement slots into the unexpired term.  Governors consequently have vastly different effective terms, though governors can also be reappointed when their terms expire, which happens frequently; it was the case for both current Fed Chair Powell and Vice Chair Quarles.

Meanwhile, the chair of the board of governors, the vice chair, and the vice chair for supervision are serving not only their governor terms but also 4-year terms in their leadership positions.  In theory, someone who loses a leadership position—even the chair—but has time remaining in their governor term may stay on, though that has happened only once in the past.

Current makeup of the board

President Trump left office with one open seat on the Federal Reserve Board, as his nominee Judy Shelton, was controversial and never mustered sufficient support to gain confirmation in the Senate.  Governors Bowman, Brainard and Waller are all serving terms that do not expire during the current presidential term, so they will remain in place through Biden’s first four years unless one of them departs the Fed voluntarily.

However, all three of the leadership positions are about to come open.  Chair Powell’s 4-year stint as chair expires on February 5, 2022, though his term as governor extends to 2028.  Vice Chair Clarida’s term as governor expires on January 31, 2022.  Finally, Governor Quarles’ term as vice chairman of supervision expires October 31, 2021, though his term as governor goes until 2032.

President Biden consequently has an unusual chance to fill all three leadership positions within a matter of a few months.

The rest of this piece reflects extensive reporting in the general and political press including a front-page article in the Wall Street Journal and a major Bloomberg story in recent days, citing various unnamed insiders regarding thinking from the administration and key congressional players, as well as some of my own thoughts on the matter.

Chairman Powell

The most important decision that President Biden has to make, of course, is whether to renominate Chair Powell or select a new person to head the central bank.  At first glance, it might seem obvious that President Biden would want to go in a new direction. Jerome Powell was an explicitly “Republican” governor when he was first nominated to the board by President Obama in 2012 as part of a package of appointments.  Then he was chosen by President Trump to replace Chair Yellen to head the Fed four years ago, in part because he was viewed as closer to President Trump’s political views than Yellen. The Biden Administration is receiving a fair amount of pressure from progressives to put one of their own in the chair position.

The counter to this case is that Chair Powell, given his Republican roots, has proven to be surprisingly sympathetic to the agenda of those who have long desired a more activist Fed. The series of Fed Listens events in 2018 and 2019 ended up being a forum for a variety of interest groups such as community organizers and unions that have traditionally not gotten much of a hearing from the Fed to weigh in, and the FOMC did indeed listen.  The broad conclusion of the listening tour by the FOMC was that running the labor market hot did a lot of good in terms of generating jobs for low-income and traditionally disadvantaged workers, a view that contrasted sharply with the Fed’s decision-making in the 1980s and 1990s.  The FOMC chose to alter its framework in a decidedly dovish manner, promising to keep its policy rate at the zero bound until inflation moved to or modestly above its 2% target, no matter how low the unemployment rate goes.

As part of that shift, Chair Powell and others have also incorporated a number of long-held talking points of progressive lawmakers, including measuring full employment in part by tracking not just the aggregate unemployment rate but also joblessness for a number of gender and racial subcategories. The Federal Reserve system has also adopted the language of “equity.”  Finally, much to the consternation of many Republican lawmakers, the Fed is spending a significant amount of time and energy beginning to incorporate risks associated with climate change into its financial regulatory framework.

Chair Powell also gained popularity generally on Capitol Hill, among both Democrats and Republicans, for his steady leadership during the crisis days of the pandemic.  His aggressive interventions in the spring of 2020 are broadly viewed as having rescued financial markets and helped to avoid what could have been a much worse downturn.  Powell also gained additional favor among Democrats over the past year by explicitly and forcefully endorsing substantial fiscal relief.

Indeed, most progressive lawmakers appear quite happy with Powell’s tenure as Chair at the Fed in terms of monetary policy.  However, a number of progressive senators such as Sherrod Brown, chairman of the Senate Banking Committee, and Elizabeth Warren, have criticized the Fed’s banking regulation approach as far too lax. Opinion seems divided among progressives about whether Powell deserves another term as chair, with some supporting him and others saying that while he has been terrific on monetary policy, they would prefer someone who is equally dovish but would also make life harder for banks.  There are also some who would like to see a more diverse candidate.

Package deal

It would be nearly impossible for President Biden to satisfy all of his supporters in a single pick.  Fortunately, he has multiple spots to work with.  There is the empty board seat.  Vice Chair Clarida will almost certainly not be renominated, which opens up a second board seat and another leadership position.  Vice Chairman for Supervision Quarles will most assuredly not be renominated to run the supervision effort.  He has hinted that he might be willing to stay on as a governor, even if he loses his leadership role.  So President Biden will have to fill all three leadership posts and anywhere from two to four board seats, depending on whether he renominates Powell and whether Powell and Quarles decide to stay on if they were demoted (I would assume that, unlike Quarles, if Powell is snubbed as chair, he would leave the Fed).  This likely offers Biden enough degrees of freedom to offer something to everyone that he is hoping to please.

Based on press reports and my own sense, I predict that President Biden will renominate Powell to run the Fed for four more years.  Then, he will elevate Lael Brainard, the only holdover “Democratic” appointment currently on the Board, to replace Randy Quarles as head of supervision.  This kills two birds with one stone, as Brainard would be the most logical choice to replace Powell with a “more Democratic” person, and she has been publicly critical of the Fed’s regulatory stance as too friendly toward banks.  So elevating her would offer some satisfaction to those who may be pushing her for chair.

President Biden would then have at least two open board slots and the vice chair position to find candidates who are diverse and would be viewed by progressives as taking the committee further in a leftward direction.  We could see a mix: perhaps an ethnically diverse academic economist with monetary policy experience and someone else with a different background who might be put forth as a representative of underserved communities, with one of them filling the vice chair position.  If Randy Quarles chooses to exit the Fed, then Biden would have three slots to work with and could conceivably push the Federal Reserve Board even further in a leftward direction.

Monetary policy implications

As described above, the FOMC has already swung significantly in a dovish direction.  It is pretty easy to surmise that the committee will be even more dovish after President Biden’s nominations are installed than it is today.  It might seem like a foregone conclusion that the Fed will run a far easier monetary policy than it has historically.

To use an economics hedge term, that will be true “all else equal.”  However, the entire dovish shift in the Fed’s framework formally adopted in 2020 presumed that inflation will remain generally quiescent, even in the face of a hot labor market, as it did in the years just before the pandemic.  If the last economic cycle turns out to be an anomaly and inflation proves to be more persistent and hotter than seen in the last few decades, even those who might be nominally dovish would be faced with a new and different economic landscape that might lead to unpredictable responses.  Moreover, the 12 Federal Reserve Bank presidents, while outvoted on the FOMC strictly speaking, will undoubtedly help to drive the direction of the committee and may offer heavy resistance to running a dovish policy stance if inflation is clearly running above the FOMC’s 2% target.  So while a very dovish Fed is a good bet, the economic outlook could shuffle the deck in ways that would be hard to predict.

Stephen Stanley
1 (203) 428-2556

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