Jérôme Powell or Lael Brainard? An explanation of the Federal Reserve system and who could be the next Fed chairman

By Friday, US President Joe Biden is expected to announce his candidate for the post of Chairman of the Federal Reserve.

The mandate of the current holder of this function, Jerome Powell, expires February 5. Powell is also the lead candidate, who is expected to be reappointed by the Biden administration.

But it’s a little more complicated than that …

Master of the greenback

As the head of the central banking system of the world’s largest economy, the Fed chairman wields considerable power. He or she is often seen as “the person who wields the greatest immediate power over the world economy” and his or her position as “the most important post in the world economy”.

(Of course, the governor of the People’s Bank of China would be an obvious competitor for these laurels if it weren’t for the fact that, unlike Beijing, Washington can only go so far in reducing the independence of its central bank.)

To understand the importance of the Fed Chairman’s role in the global economy, it is important to understand the US central banking system.

Structure of the Federal Reserve: an introduction

The Fed has three main components.

• A, the Federal Reserve Board of Governors (FRB), which includes seven governors appointed by the President and confirmed by the Senate. They serve staggered terms of 14 years. (RBI equivalent: Central Board of Directors.) The Fed chairman is chosen from the existing FRB pool for a four-year term and chairs board meetings as an “active executive director”. (RBI equivalent: governor.)
• Of them, twelve regional Federal reserve banks located across the United States, which regulate and supervise private commercial banks. (RBI equivalent (sort of): the four local councils of Mumbai, Chennai, Kolkata, and New Delhi.)
• Three, the Federal Open Market Committee (FOMC), which is the Fed’s rate-setting body and therefore the body that sets US monetary policy. It has 12 members (the seven governors of the FRB + five of the 12 regional presidents of the Federal Reserve). (RBI equivalent: Monetary Policy Committee.)

Federal Reserve and RBI: A Brief Comparison

At a fundamental level, the Fed and the RBI are just two sides of the same coin. Much like the Indian Central Bank, the Fed is responsible for managing inflation, overseeing the country’s banking system, maintaining the stability of the financial system, and providing banking services to the government. Like the RBI, it also regularly conducts economic research. And just like the RBI, it must systematically repel undue political interference to preserve its independence.

However, there are also some critical differences between the two.

The RBI is a fully nationalized autonomous public establishment placed under the supervision of the Ministry of Finance. The Fed has both public and private components within its structure (Federal Reserve Banks are set up as private companies). The RBI’s central board is a 21-member body that includes two representatives of the Union government (which conveniently remains oblivious to the college idea). The FRB, on the other hand, does not have representatives from Washington. The governor of the RBI is appointed by the Union government. The appointment of the Fed chairman is subject to the approval of the Senate Banking Committee and to the vote of the entire Senate.

In terms of functioning, the two institutions differ only because of the size of the economies they manage. America is obviously a more developed economy with more moving parts and sophistication. Its banks are larger and manage larger assets. Its actions are more closely watched around the world and seen as precursors. The RBI, on the other hand, has a different set of priorities, with an economy that remains agro-centric and largely unorganized. India’s financial sector is also relatively nascent. But its digital economy and payment infrastructure are vast. So each central bank has its own set of challenges.

One chair to rule them all

Who sits on the throne in the Eccles Building is a big deal. This person would control U.S. interest rates, regulate some of the world’s largest banks, and oversee an $ 8.3 billion balance sheet. He / she also oversees the Federal Reserve Banks, which issue US dollar banknotes – the world’s reserve currency.

It can be argued that the president’s main responsibility is to implement the task of maximizing employment while stabilizing prices, i.e. the “dual mandate” of the Fed, which was subsequently adopted. of the stagflation in the 1970s.

Fed chairmen have generally been historically important figures. Guillaume Martin, the longest-serving president, was famous for fiercely defending the institution’s independence. In 1965, an enraged President Lyndon Johnson allegedly physically pushed Martin against the wall, shouting “Martin, my boys are dying in Vietnam, and you won’t print the money I need!” (Martin didn’t move.)

Paul Volcker implemented controversial (but effective) measures to avoid stagflation by advancing rate hikes. Alan greenspan aka “The Maestro” earned Raghuram Rajan’s rockstar reputation on Wall Street, but his “easy money” policies have been criticized for causing the dot-com bubble and subprime mortgage crisis. “The height of calm” Ben bernanke oversaw the Fed’s response to the Great Recession of 2007-09 while launching quantitative easing and overseeing the bank bailouts of the time. His successor, Janet Yellen, the first president in the history of the Fed, began the process of canceling key rate cuts (quantitative tightening) at the end of 2017 and focused on controlling unemployment. (Yellen is now the US Secretary of the Treasury.)

And then there’s Powell.

Powell’s tenure

Powell was appointed by Donald Trump, who broke a decades-long precedent by deciding not to re-elect the current president (Yellen). He began by continuing the quantitative tightening policy of his predecessor, gradually raising rates in the light of solid economic indicators. This brought him into a direct confrontation with the White House. Trump has repeatedly called for zero or negative interest rates to stimulate growth, even ridiculing Powell as an “enemy” and “equal or worse than” Xi Jinping. The president, however, held on.

Powell’s response to the COVID-19 pandemic has garnered bipartisan praise. He initiated a dramatic expansion of the central bank’s balance sheet and led unique bond buying and direct loan programs. Significantly, at Jackson Hole Summit 2020, he signaled the end of the Fed’s decades-long obsession with inflation targeting (a legacy of Volcker). Instead, the Fed would allow interest rates to stay near zero levels and tolerate small increases in inflation to support economic growth.

Today, however, towards the end of his tenure, Powell faces a changed landscape. The pandemic in the United States has started to recede thanks to the vaccination campaign. Economic activity is picking up steam, so the Fed will “Reduce” your monthly asset purchases. And all eyes are on the U.S. inflation rate, which is now at its highest level since 1990.

Power of Powell

Despite being the overwhelming favorite to be Biden’s choice, Powell has his fair share of criticism. Those on the right criticize its quantitative easing policies and say the Fed did not predict the sharp rise in consumer prices. Those on the left deplore his support for financial deregulation and call for a more climate-conscious candidate.

In the midst of all this debate is the wild card – Lael Brainard, another member of the FRB. She has gained the reputation of being the “The Strongest” vote in Council for stricter regulation of the financial sector. Critically, she has the support of the progressive wing of the Democratic Party, which after its compromises for the recent infrastructure bill and the roll-back of his darling Billionaire income tax might be less inclined to negotiate with moderates who support Powell.

However, the evidence strongly suggests that, if confirmed, Brainard will likely choose to continue the gradual tightening of Powell’s policy, albeit at a more gradual pace. The main area of ​​difference is regulation – Brainard has always opposed relaxing regulatory restrictions on financial institutions, unlike Powell (which led Senator Elizabeth Warren to call her a “dangerous man”) .

But precedents and bipartisan considerations give Powell the edge. It is the favorite of the betting markets, which gives it a 73% likelihood of re-appointment, although his margin vis-à-vis Brainard has narrowed in recent weeks.

But then again, bettors are not deciding who will be the next chairman of the Federal Reserve!