The Senate should reject Jerome Powell

Today, the Senate Banking Committee is holding a hearing on whether Federal Reserve chair Jerome Powell should be awarded a second four-year term.  The Senate should reject the nomination.

As we explained on April 26, Powell doesn't understand economics.  He couldn't even see the difference between President Trump's economy, in which increased supply made inflation unlikely, and President Biden's economy, in which reduced supply made inflation almost inevitable.

Back then, prices were going up at a 2.6% rate according to the most recent release (March 2021) of the Consumer Price Index (CPI).  Now, according to the most recent CPI (November 2021), inflation is going up at a 6.8% rate.  Tomorrow, the December CPI will be reported, and the consensus estimate is that it will go up to 7%.

Jerome Powell has printed too much money, has stoked inflation by cutting supply, has taken incompetent actions against inflation, and is currently creating inflationary expectations that could increase both inflation and unemployment for decades.  We will discuss each of these huge mistakes in turn.

Printing Too Much Money

Mismanagement of the money supply by the Fed can have massive consequences for the economy.  For instance, in what was arguably the worst Fed mistake ever made, Roy Young and Eugene Meyer presided over a contraction by one-third in the U.S. money supply (1929 to 1932), which greatly extended and intensified the Great Depression.

When Federal Reserve chair Ben Bernanke encountered the same sort of financial collapse at the beginning of the Great Recession in 2008, he invented quantitative easing (massive buying by the Fed of both short-term and long-term government bonds) to make sure that the U.S. money supply wouldn't fall.  Bernanke succeeded.  QE1 (the first version of Quantitative Easing) was a great success.  

Powell responded to the COVID-lockdown recession with a massive quantitative easing effort despite the fact that this was not a money-destroying financial crisis.  Where Bernanke's actions kept the money supply relatively stable despite a financial crisis, Powell's actions induced the most rapid growth in the U.S. money supply since at least 1960.

Stoking Inflation by Cutting Supply

Powell is actually taking actions that stoke inflation.  In his renomination message, President Biden praised Powell's belief that "urgent action is needed to address the economic risks posed by climate change," perhaps a reference to changing finance costs that are reducing oil and gas development.

Powell is thereby accelerating the very inflation he is supposed to fight when he prevents banks from making loans to fossil fuel developers, loans that would reduce the future prices of energy, increase U.S. energy exports, and reduce energy imports.

Some recent evidence suggests that predictions of catastrophic global warming are based upon a mathematical error.  Be that as it may, decreasing the supply of energy is a clear recipe for inflation as demonstrated in the 1970s.

Incompetent Actions against Inflation

Past chairs of the Federal Reserve have "tapped on the brakes" when inflation started to rise above 3%, but Powell has refused to do much of anything, relying through most of 2021 on wishful thinking about "transitory" inflation instead of action, and his own untrained intuition instead of economic understanding or the Federal Reserve's own economics models.  (The sum total of this lawyer's economics course work was the introductory economics course he took as an undergrad.)

In the early days of the pandemic, the impact of his massive increase in the money supply may have been dampened by a diminished velocity that money changed hands due to lockdowns and other pandemic precautions.  But as the economy has reopened, inflation has, too.  Basic monetary theory states that a massive increase in the money supply is going to cause inflation.  And it is causing it now.

Powell's planned actions appear likely to be too little and too late.  According to Federal Reserve minutes released recently, he doesn't plan to end quantitative easing until March and plans to raise interest rates only three times during 2022, probably by about a quarter percent each time, bringing the U.S. short-term interest rate up to about 0.8%.  This is not nearly enough to make much of a dent in an inflation rate that is much higher than that.

Creating Inflationary Expectations

Powell seems to be intent upon repeating the mistake made by Federal Reserve chair William McChesney Martin, who let inflation rise from 3.0% in 1967 to 4.7% in 1968 to 6.2% in 1969 (according to the CPI).  Like Powell, Martin was doing so in order to facilitate the tremendous increase in government spending being made by his president.

In December 1967, while Martin's inflation rate was climbing, Milton Friedman, then head of the American Economic Association, urged in a speech at its annual meeting (PDF) that the Federal Reserve be required to stick to a target of 3–5% monetary growth.  If his recommendation had been followed, the economic malaise of the next 15 years would have been avoided.

The problem is that once the inflation rate gets high enough, inflationary expectations change.  Lenders begin demanding higher interest rates, and workers begin demanding higher wage rates so as to keep up with inflation.  The following graph (used with permission) by conservative economists Paul R. Gregory and Roy J. Ruffin shows that inflationary expectations jumped up in 1969, 1973, and 1979:

As shown, each jump upward in inflationary expectations resulted, simultaneously, in a new relationship between inflation and unemployment, with both being generally higher than previously.  (Note: The inflation rate shown in the above graph was calculated from the GDP Price Deflator, which is more accurate than the CPI but not reported as quickly.)

Powell is playing with fire.  Once inflationary expectations get going, they are very difficult to bring down.  After the inflation-ridden 1970s, in which the buying power of a dollar dropped by more than 50 percent, it took President Reagan's supply-side economics combined with Federal Reserve chair Paul Volcker's reduced money supply growth to finally bring things down.  And, as anyone who lived through that period can attest, it required sky-high interest rates and a painful recession.

The Senate must reject Powell.  If they don't, it will take another supply-side president, such as Ronald Reagan or Donald Trump, and another Paul Volcker at the Fed to bring down the inflationary expectations that the incompetent Jerome Powell is now creating.

The Richmans co-authored the 2014 book Balanced Trade, published by Lexington Books, and the 2008 book Trading Away Our Future, published by Ideal Taxes Association.

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