Powell's Perilous Situation

28 Pages Posted: 15 Mar 2018 Last revised: 10 Nov 2021

See all articles by Francis E. Warnock

Francis E. Warnock

University of Virginia - Darden Business School; National Bureau of Economic Research (NBER)

Abstract

In February 2018, Jay Powell replaced Janet Yellen as chair of the Board of Governors of the US Federal Reserve (the Fed). Powell, a board member at the Fed since May 2012, knew that his job was to normalize US monetary policy, which had been exceptionally expansionary for a full decade. He also knew that short rates had been too low for too long—the federal funds rate had been near 0% for seven years and even now was at a historically low level of just 1.25%—perhaps sowing the seeds for future financial crises. Powell faced at least three pressing questions: How, after the Fed's balance sheet had expanded fourfold in a few short years, should the Fed guide the public through the eventual unwinding of its $4.4 trillion balance sheet? Relatedly, when should it begin to sell some of its $2.46 trillion in Treasury holdings? Could the US economy—and, indeed, the global economy—weather a substantial tightening phase, or would the US economy falter and force the Fed to reverse course? The focus of this case is on factors affecting the current and prospective levels of US long-term interest rates. The case also presents a brief history of Fed policy and asks the reader to consider the best course of action for the Fed to take. This case was written as an updated version of “Janet Yellen: Navigating Uncharted Waters” (GEM-0134), and may be used in its place. It is used at Darden in the second-year elective, “Global Financial Markets.” It would also be suitable for any macro or international macroeconomics course.

Excerpt

UVA-GEM-0156

Rev. Jan. 25, 2019

Powell's Perilous Situation

We shouldn't underestimate how perilous the situation is. You have massive tax cuts and [a] potentially very large increase in federal spending coming; when the unemployment rate is already very low and inflation is already rising—which is a largely unprecedented situation…This point in the cycle is the most difficult for monetary policymakers to manage.

—Seth Carpenter, UBS Chief US Economist

In January 2019, Jay Powell, one year into his term as chair of the Board of Governors of the USFederal Reserve (the Fed), must have felt he was dealt a bad hand. Powell followed Janet Yellen, a highly successful Fed chair who, during her four-year reign, started to tighten the Fed's extraordinarily loose monetary policy (a remnant of the global financial crisis, or GFC) and got closer to the Fed's 2% inflation target as nine million Americans became employed, the unemployment rate fell to a historically low 4%, and economic growth was poised to perform better than any year since 2005. And during Yellen's regime, the stock market increased by 70% and the 10-year Treasury yield—arguably the most important price in the global economy—was no higher than when her term began (Figure 1).

. . .

Keywords: Fed, Federal Reserve, Powell, Yellen, financial crisis, monetary policy, stock market, funds rate, treasury, inflation, bond, Greenspan, Volcker, interest rate

Suggested Citation

Warnock, Francis E., Powell's Perilous Situation. Darden Case No. UVA-GEM-0156, Available at SSRN: https://ssrn.com/abstract=3140855 or http://dx.doi.org/10.2139/ssrn.3140855

Francis E. Warnock (Contact Author)

University of Virginia - Darden Business School ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States
434-924-6076 (Phone)

HOME PAGE: http://faculty.darden.virginia.edu/warnockf/index.htm

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138-5398

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