Update 508 — Recovery Still “Uncertain,”
Powell Reminds Congress, Citing Jobs Lag
In his first appearance before the 117th Congress, Federal Reserve Chair Jerome Powell presented the semi-annual Monetary Policy Report in hearings before Senate Banking yesterday and House Financial Services today. Powell depicted an economy still suffering from the pandemic and warned of risk of a slower return than necessary to pre-pandemic employment levels.
Powell declined to offer opinions regarding the stimulus package under negotiation, which we will cover Friday. But he pushed back on inflation concerns pointedly. Instead, he focused on the contents of the Monetary Policy Report, specifically the labor market. Below, we review the Fed’s pandemic response and monetary policy decisions, as well as its regulatory actions.
The Federal Reserve’s Pandemic Response
At the start of the pandemic, fears of the relatively unknown illness kept people from traveling and engaging in common economic activities, prompting a severe economic contraction. Certain sectors such as tourism, leisure, and services bore the brunt of the economic downturn. The Federal Reserve intervened with a broad array of actions to limit the pandemic’s economic damage, including a total of $2.76 trillion in large-scale asset purchases and lending. Fed lending aimed at households, employers, financial markets, and state and local government, helped alleviate the crisis. Certain efforts performed better than others. While the Fed’s liquidity measures continue, its emergency facilities were wound down at the end of the year.
The Fed Chair’s testimony before both chambers focused on the latest Monetary Policy Report’s findings, specifically that labor market recovery has slowed in recent months. The economy is still more than 10 million jobs below pre-pandemic levels. These missing jobs are disproportionately held by women and minorities in low-wage roles. Though the unemployment rate officially stands at 6.3 percent, Fed and Treasury officials believe the rate is closer to 10 percent — 17 percent for the bottom quartile of wage earners. And as Powell explained in a recent speech, the current 12-month decline in labor force participation is the largest since 1948.
The Fed Chair declined to reveal whether he was “cool” or “uncool” with the stimulus package’s size and scope, despite repeated lines of questioning from members on both sides of the aisle. But Powell did push back against arguments raised by Republicans that the Biden stimulus package would lead to higher inflation, saying that a burst of fiscal support is not likely to significantly alter dynamics that have kept inflation low for several years now. Although Powell has been vocal in the past on the need for fiscal relief, his silence yesterday and today indicates a return to the pre-pandemic status quo, distancing monetary policy from fiscal.
Reviewing Monetary Policy
During the hearings this week, Powell defended the Fed’s monetary policy response to the pandemic. Powell discussed the newly adopted monetary policy framework, first announced last August, in his testimony. Under the new framework, the Fed will place a greater emphasis on its maximum employment mandate, meaning that the Fed will rely less heavily on the Non-Accelerating Inflation Rate of Unemployment theory — a highly uncertain benchmark for maximum unemployment which assumes inflation and unemployment have an inverse relationship. This marks a significant policy change by the Fed, in which the monetary policy lever will be employed more actively to accommodate wage and job growth. The policy also clarifies that the two percent inflation target is not a ceiling and the Fed will aim to keep inflation above that target.
Powell also reviewed the interest rate policy before both chambers this week. Following the initial shock of the pandemic to the economy last March, the Federal Open Market Committee (FOMC) slashed the federal funds rate from a range of 1-1.25 percent to 0-0.25 percent, referred to as the “zero lower bound” by economists.
The Fed accomplished this via a combination of forward guidance and quantitative easing, a tool last used by the Fed during the 2008 financial crisis. It purchased large amounts of Treasuries and mortgage-backed securities in order to restore liquidity to those markets, flatten yield curves, and place downward pressure on interest rates. During the height of the crisis, the Fed made purchases at a rate of $125 billion a day, and its balance sheet grew to over $7 trillion in assets.
In just under a year since these initial actions were taken, the Fed is likely to maintain an accommodative monetary policy for some time. Powell indicated in public comments that near-zero interest rates will persist through 2023, an expectation shared by the majority of members of the FOMC. The Fed has also pledged since June to maintain a rate of $120 billion a month of new asset purchases until “substantial further progress” has been made toward employment and inflation goals. The policy indicates the Fed sees full economic recovery as far from complete or assured.
Dividends and Capital Requirements
Powell deflected lawmakers’ questions regarding temporary regulatory measures enacted by the Fed last year to strengthen the financial system during the pandemic. Beginning last year, the Fed permitted large banks to hold less capital, allowing these banks to exempt certain assets from capitalization requirements under the Supplementary Leverage Ratio. Since 2016, leverage ratios at large banks have dropped significantly, but this further cut the amount of loss-absorbing capital maintained by banks to support operations. In conjunction with loosening capital requirements, the Fed added restrictions on dividend payments and stock repurchases by the largest banks with the intention of increasing bank balance sheets and lending.
But in December, restrictions on dividends and stock repurchases were lifted based on banks’ performance on stress tests, allowing them to resume paying dividends without necessarily expanding lending. The Fed Board’s vote was not unanimous. Governor Lael Brainard dissented to the decision, expressing concern that certain large banks reached their regulatory minimums for capital under certain stress test scenarios. In her dissent, she noted that at those levels of capital banks tend to pull back from lending, even before limiting payouts.
Senator Brown, Banking Committee Chair, probed this issue on Tuesday, asking Powell not to extend exemptions for capital requirements for banks that have continued to pay dividends. Powell did not commit to connecting the two decisions. The temporary loosening of capital requirements is set to expire at the end of March. Per Powell, the Fed has not yet decided whether the temporary measure will be renewed, but banks continue to lobby the Fed to extend the SLR exemption.
The Continued Need for Relief
In his prepared remarks, Powell noted that “the economic recovery remains uneven and far from complete, and the path ahead is highly uncertain.” He warned of a shaky recovery, especially for the labor market, and reinforced the central bank’s commitment to maintaining near-zero interest rates and continuing quantitative easing for the foreseeable future. Though Powell refused to opine on President Biden’s $1.9 trillion proposal, his comments all support the necessity of the new stimulus package to provide relief for a struggling labor market and help promote and accelerate the hoped-for recovery.