Jerome Powell, the Fed and the Empty Punch Bowl
As Federal Reserve chairman Jerome Powell confronts the prospect of a double digit inflation rate, it's been fashionable to compare him to Paul Volcker, the legendary Fed boss who jacked interest rates up to nosebleed levels in 1980 – the last time prices rose this fast.
Implicit in the comparison is that Volcker had something in him that Powell lacks. Namely a moral authority and an ability to bend fractious markets to his will. When Volker took office in August 1979, inflation was running hot at 15 percent. After a decade of stagflation, it had become a popular view in policy circles to argue that there was not much the central bank could do to tame inflation in the face of runaway government spending, skyrocketing oil prices and rampant wage pressures.
Volker had other ideas. In a matter of months, he pushed interest rates up from 11 to 20 percent. A punishing recession ensued but by 1983, inflation had fallen below 3 percent. Thus was born the legend of Paul Volcker – the first central banker to assume a renown beyond the narrow precincts of Washington and Wall Street.
Powell and Volker: the contrast is stark. Volcker stood 6-foot-7, wore cheap suits and when he came before Congress to lecture the country about the evils of inflation, wreathed in a cloud of cigar smoke, he seemed more Old Testament prophet than glib Washington technocrat.
His very essence – stern, preachy, unyielding – would stand as a rebuke to the loose money policies (and attitudes) ushered in by his successor Alan Greenspan and that found their full and final expression under Powell.
I would argue though that a more revealing comparison would be between Powell and William McChesney Martin, Jr., who was chairman from 1951 to 1970. Martin was the second longest serving chair in history and a man who – before the rectitudinous Volcker came along – set the standard of a Fed chair commanding fear, as opposed to enabling greed, in financial markets.
Martin grew up in a staunch Presbyterian household in St. Louis and, reportedly, even considered entering the ministry. Wall Street beckoned instead and he started work as a broker in 1931, just two years after the 1929 crash. He rose to prominence quickly and was among a select few bank executives who pushed for strong regulatory measures to protect against another financial disaster.
He was appointed Fed chair in 1950 and made his name by pushing back hard against the White House in terms of the Fed’s mandate to keep the economy from overheating – at the cost of a higher rate of unemployment.
President Nixon would blame him for costing him the presidency in 1960 and in 1970 Nixon got his revenge, finally moving him from office on the excuse that Martin was still keeping rates too high.
The words that central bankers speak come to define them in Wall Street mythology. In 1996, when Internet stocks were soaring, Greenspan mused about the irrational exuberance of the stock market – and the phrase is now part of the financial lexicon.
His successor, Ben Bernanke, came to be known as Helicopter Ben for claiming in a speech that a central banker might fight deflation by printing limitless money, akin to a theoretical helicopter drop of cash on a moribund economy.
For Martin, it was the punchbowl. In a talk he gave in 1955, he likened the responsibility of the Fed chair to keep the economy from growing too fast to that of a chaperone – who has ordered the punch bowl removed just when the party was really warming up.
The remark is apt metaphor, which is why it has been recycled time and again over the years. More than that though, it speaks to the man himself.
Check out his picture.
McChesney Martin has precisely that look of a severe 1950s era chaperone at a high school prom. Hair slicked tightly back, spectacles and a grim, pinched face. Reportedly, he did not smoke or drink. New York Times columnist James Reston dubbed him the happy puritan in a column he wrote in 1970.
So, when it comes to the charge of leaving the punchbowl out for too long and suffering the consequences – high inflation, overheating asset markets – Powell, more than any of his fast money predecessors, must take the blame.
At a time when it was clear that inflation was a potential threat, Powell kept rates at rock bottom levels. Moreover, he took such a stand just as the government was flooding the economy with cash in the early days of the pandemic. Instead of acting as a restraint, per its mandate, lax Fed policy was an accelerant, pushing asset prices to historic highs in late 2021 and leaving prices to fester.
The best way to gauge this is to subtract the Fed's main rate of interest from the consumer price index, which gives you a true gauge of how loose or tight a Fed policy is.
Here is how one former Fed official describes it.
Powell’s problem is all the more evident when viewed through the inflation-adjusted lens of real interest rates. Over the 51 months of his leadership of the Fed (through April 2022), the real federal funds rate has averaged -1.95% (with a stress on the minus sign). This extraordinary monetary accommodation is unmatched in modern times.
Powell may have taken away the punch bowl, but it was empty when he did so.