The imminent decision of the president of USA, Joe Biden, about whether to bring the chair back from the Federal Reserve, Jerome Powell, after his term ends in February or handing over the reins to someone else, will come at a critical time for the US central bank.
You democrats progressives want the Fed to take a broader role in the economy, intensifying efforts to boost employment, avoiding climate risks and tackling inequality. You conservatives they want him to stick to monetary policy, paying more attention to curbing inflation and reducing his footprint on the financial markets and the supervisory front.
Whichever the Democratic president chooses, the next Fed chief will need to resolve the main questions about monetary policy and the nature of money.
Here are some of the biggest challenges of the next four years:
GETTING MONETARY POLICY RIGHT
After the coronavirus hit, the Fed cut its benchmark interest rate to almost zero and bought trillions of dollars in Treasury bonds and mortgage-backed securities.
With the economy recovering quickly, Fed officials will likely begin to slow down asset purchases later this year.
But under a new monetary policy framework adopted last August, they plan to wait to raise interest rates until the economy reaches full employment, and inflation is at 2% and on track to moderately exceed that level.
It’s a promise a new Fed boss may have a hard time keeping. Most Fed monetary policy makers believe the current surge in inflation above 2% is temporary. But if price increases prove more persistent, whoever heads the central bank could end up supervising a rate hike before all aspiring workers get a job.
In August, there were 5.3 million Americans less employed than before the pandemic.
“There are a lot of things that will be different going forward that are implicit structural aspects of the economy that I think we’ll have to pay close attention to to make sure we’re properly calibrating our policy for the economy,” said Cleveland Fed Chair Loretta Mester, in an interview in August.
FED AS REGULATOR
If the Fed’s new structure keeps monetary policy looser longer in pursuit of a stronger labor market, analysts say, it may be necessary to tighten financial regulations to avoid risky behavior that could precipitate a crisis.
“Financial regulation, in my opinion, is second on the agenda, and especially continuing to address the issue of containing financial risk in an environment of historically low interest rates,” said David Wilcox, former Fed economist and currently a researcher at the Peterson Institute for International Economics.
Those leading the Fed also need to look at financial stability more broadly, Wilcox said.
Systemic weaknesses in the way Treasuries and currency markets trade were exposed last March by the near-collapse of financial markets following the pandemic-related outages.
The growing popularity of “stablecoins,” a largely unregulated form of cryptocurrency that can be pegged to the dollar, also poses a growing threat to financial stability, argued Boston Fed President Eric Rosengren.
A key question will be whether the Fed decides to issue its own digital currency. Powell has not committed to this until now. Fed director Lael Brainard, another top candidate for the chair of the US central bank, said she finds it difficult not to. The Fed plans to publish a discussion paper on the matter in September.
Proponents say a well-designed digital currency can reduce transaction costs and increase access to the banking system for disadvantaged groups. Others worry that banks could be sidelined if American families and businesses forgo regular checking accounts and go directly to the Fed.
China and other countries are already issuing their own digital currencies, as are private companies like Amazon.com Inc. If widely adopted, these tokens could fragment the payments system, threaten the Fed’s ability to control interest rates and put it at risk the global dominance of the dollar.
“The Federal Reserve needs to unravel this very quickly,” said Andrew Levin, an economics professor at Dartmouth College. “This is a challenge where the dust can settle within a year or two.”
The Fed chief will also be under pressure to understand and deal with the economic and financial implications of wildfires, super-powered hurricanes and other devastating impacts of climate change.
Both Powell and Brainard say it is the Fed’s job to ensure banks are resilient to, for example, declines in asset values due to extreme weather events or government orders to limit carbon dioxide emissions.
But the Fed’s mandate does not include any mandate to fight climate change directly, as is the case with some other central banks.
The Fed created two internal dashboards last year, one focusing on weather-related risks at individual banks and the other on system-wide threats. It also became the last major central bank to join a greener financial system network that develops recommendations for central banks to respond to climate change.
Both could be ways for the Fed chief to do more on the climate front, although a more aggressive stance on parity with other central banks could be difficult without new legislation.
RACIAL AND GENDER GAPS
Fed officials have also become more outspoken about the potential for racial and gender inequalities to hamper economic growth.
“This is causing a lot of unease about what the Fed is doing to address some of the big problems of our day, which include inequality and disparities in labor market outcomes and wealth distribution,” said Julia Coronado, a former Fed economist who he is now president of MacroPolicy Perspectives.
Whoever runs the Fed could tweak their tools to potentially close some of those gaps, including through programs aimed at increasing lending to small businesses and supervisory changes that encourage banks to work with consumers struggling to repay their loans, he said. Coronado.
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