The fact that there are only winners at the end of a long political squabble happens about as often as the joint participation of Markus Söder and Wolfgang Kubicki in a four-week humility seminar. Joe Biden, however, has now succeeded in doing just that with his rebuilds at the US Federal Reserve. Jerome Powell, who in the past four years at the top of the Fed had to defy Donald Trump and then the virus, is allowed to continue. Lael Brainard, the favorite of many of Biden’s party friends, will not be promoted to boss, but to deputy chief of the world’s most important economic and political authority. And if you believe the signals from the White House, then the entire Fed Executive Board will soon represent US society much better than the club of predominantly older white men has been able to do so far. So everything was done right.
This is all the more true as Biden was under a lot of pressure internally: Left party friends in particular had pointed out right up to the end that the president would fill five new posts and positions on the seven-person Fed executive board and thus give the central bank a bold coat of paint for a long time Blue could miss – the party color of the Democrats. The fact that Biden resisted the temptation to fire the registered Republican Powell despite a good job shows how seriously he takes central bank independence and how important it is whether the White House is ruled by a principled president or a self-indulgent populist.
However, Powell and Brainard do not have time to collect themselves and quietly wait for their nomination to be confirmed by the Senate. On the contrary: after more than a decade of ultra-low interest rates and the repeated risk of deflation, the Fed is now facing exactly the opposite risk scenario and the biggest test since the global financial crisis: at 6.2 percent, the US inflation rate is at the level last seen in 1990, not a few economists believe a further increase to over seven percent is likely.
Many experts have not recognized the danger for a long time
For a long time, many experts had closed their eyes to the problem and bet that the dramatic rise in prices will prove to be short-lived consequences of the pandemic and that you can therefore put your hands on your lap. Meanwhile you know: you can’t. Some of the corona-related production and delivery difficulties will actually go away on their own. However, prices are now rising at a pace and on such a broad front that the thought is beginning to settle in many people’s minds that it could possibly be a permanent problem after all. This is very dangerous for a central bank: if the so-called inflation expectations change, the risk is immense that what is actually a harmless surge in inflation will develop into the universally feared wage-price spiral, which is usually followed by recession and unemployment.
The old and probably new Fed Chairman Powell must now switch from economic support to anti-inflation mode quickly and decisively. That does not mean that he should hike key interest rates frantically – that, too, would be a recipe for an economic slump. It does mean, however, that the central bank must make it unmistakably and credibly clear that it is taking the price development and the concerns of people bitterly seriously and that it will actually take vigorous countermeasures if necessary. The economy and consumers would also be able to cope with a clearly communicated step-by-step increase in the key interest rate to almost two percent until the end of 2023. At the same time, the Fed could replenish its toolkit and concentrate more on the many structural price drivers that will remain after the pandemic has been overcome.
However, the central bank will not be able to fix it all on its own – Biden has also recognized this: In order to lower gasoline prices, he released part of his country’s strategic oil reserves for general sale just one day after his Fed personnel decision.