Axios AM Deep Dive: The Fed

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Markets

Axios Markets

We're not in the throes of a "Greater Depression," and we're not facing a tsunami of bankruptcies. In fact, the stock market is hitting new record highs, while employment is rising fast. For all of these things, thank one institution above all others: the Federal Reserve.

Why it matters: The coronavirus crisis has made abundantly clear the awesome power of central banks in general and of the Fed in particular. 

The big picture: Most of the time, the Fed is a deliberately slow and quiet agency, keeping a close eye on thousands of economic indicators and trying its best to keep employment high and inflation low. 

In a crisis, however, the Fed has now shown beyond any doubt that it is both willing and able to create as much liquidity as is needed to put out all fires and get the economy floating happily again. 

As Minneapolis Fed Chair Neel Kashkari memorably put it on "60 Minutes" in March 2020: “There is an infinite amount of cash in the Federal Reserve. We will do whatever we need to do to make sure there’s enough cash in the banking system.”

How it works: The Fed, working hand in glove with the Treasury, announced a long list of programs in March 2020, all of which were designed to stabilize extremely jittery markets and make sure that creditworthy businesses had access to the capital they needed to get through the crisis. 

The programs worked better than anyone initially dared to hope — in fact, they worked so well that many of them barely needed to be used. The sheer fact that the Fed was willing to step in sufficed to get the private markets lending again. 

Investors celebrated. With ample funding secured, even in the midst of a crisis, they knew that corporate America would be able to make it through the pandemic and take full advantage of some $5.4 trillion in pandemic-related stimulus funds. 

Setting interest rates at zero also gave investors every incentive to focus on large future profits (think fast-growing technology companies and other speculative investments) rather than concentrating on present-day cash flows.

The downside to the Fed's intervention: Businesses are mostly owned by the rich, who got richer even as total employment plunged during the crisis.

There is moral hazard involved in bailing out risk-takers rather than forcing them to suffer losses. And stocks are now so expensive that the Fed risks having to fight yet another crisis should the current bubble burst chaotically.

The bottom line: As Bloomberg's Brian Chappatta writes, the Fed's intervention in March 2020 came "not a moment too soon for many U.S. businesses to stay afloat. That seems like a worthy trade-off for some potential future moral hazard risk."

1. To infinity and beyond

The Federal Reserve and it's "infinite amount of cash"

Photo illustration of the Federal Reserve

Photo illustration: Annelise Capossela/Axios. Photo: Stefani Reynolds/Bloomberg via Getty Images

Federal Reserve

Jobs

We&#x27;re not in the throes of a &quot;<a class="gtmContentClick" data-vars-link-text="Greater Depression" data-vars-click-url="https://www.project-syndicate.org/commentary/coronavirus-greater-great-depression-by-nouriel-roubini-2020-03?barrier=accesspaylog" data-vars-content-id="2fe2efaa-936e-47a3-b422-c7730d63e9ef" data-vars-headline="To infinity and beyond" data-vars-event-category="story" data-vars-sub-category="story" data-vars-item="in_content_link" href="https://www.project-syndicate.org/commentary/coronavirus-greater-great-depression-by-nouriel-roubini-2020-03?barrier=accesspaylog" target="_blank">Greater Depression</a>,&quot; and we&#x27;re not facing a <a class="gtmContentClick" data-vars-link-text="tsunami of bankruptcies" data-vars-click-url="https://www.nytimes.com/2020/06/18/business/corporate-bankruptcy-coronavirus.html" data-vars-content-id="2fe2efaa-936e-47a3-b422-c7730d63e9ef" data-vars-headline="To infinity and beyond" data-vars-event-category="story" data-vars-sub-category="story" data-vars-item="in_content_link" href="https://www.nytimes.com/2020/06/18/business/corporate-bankruptcy-coronavirus.html" target="_blank">tsunami of bankruptcies</a>. In fact, the stock market is hitting <a class="gtmContentClick" data-vars-link-text="new record highs" data-vars-click-url="https://www.axios.com/sp500-milestone-57c77140-7f39-45b0-9e86-68fbca5fddff.html" data-vars-content-id="2fe2efaa-936e-47a3-b422-c7730d63e9ef" data-vars-headline="To infinity and beyond" data-vars-event-category="story" data-vars-sub-category="story" data-vars-item="in_content_link" href="https://www.axios.com/sp500-milestone-57c77140-7f39-45b0-9e86-68fbca5fddff.html" target="_self">new record highs</a>, while employment is <a class="gtmContentClick" data-vars-link-text="rising fast" data-vars-click-url="https://www.axios.com/newsletters/axios-thought-bubble-bd9b9f69-e606-43ab-bca6-f4317aa3276e.html?utm_source=newsletter&amp;utm_medium=email&amp;utm_campaign=thought-bubble-ampm&amp;stream=top" data-vars-content-id="2fe2efaa-936e-47a3-b422-c7730d63e9ef" data-vars-headline="To infinity and beyond" data-vars-event-category="story" data-vars-sub-category="story" data-vars-item="in_content_link" href="https://www.axios.com/newsletters/axios-thought-bubble-bd9b9f69-e606-43ab-bca6-f4317aa3276e.html?utm_source=newsletter&amp;utm_medium=email&amp;utm_campaign=thought-bubble-ampm&amp;stream=top" target="_self">rising fast</a>. For all of these things, thank one institution above all others: the Federal Reserve.Why it matters: The coronavirus crisis has made abundantly clear the awesome power of central banks in general and of the Fed in particular.

After a record economic expansion, the coronavirus pandemic sent the U.S. economy into a recession as unemployment soared to staggering heights. The country now faces urgent questions about how much stimulus is needed for reeling consumers and businesses, and what a recovery might look like.

Economy & Business

Macro

Axios Macro

Historically untouchable issues — like climate change and race — are now on the table for the Federal Reserve, as it wades further into uncharted territory. 

Why it matters: The about-face has implications for how one of the world’s most influential economic bodies steers policy and regulates the nation's banks.

What's going on: The Fed recently set up two committees to look at the impact of climate change on the economy and banks — a sign previous moves on this front are getting some traction. 

Between the lines: It may feel small, particularly for issues that have threatened and plagued the country for years. 

But it’s a big deal for an institution that rarely — if ever — spoke publicly about these issues, let alone interwove them into considerations about the economy.

On climate: The Fed is behind its peers around the globe where climate change is less politicized. 

Last year the Fed became the last to officially join a central bank climate network that’s been around since 2017.

Another example: The Bank of England will incorporate climate into stress tests on banks — something Fed Chairman Jerome Powell says is in the "early stages" of consideration. 

On race: Fed officials have implied that the national unemployment rate wouldn’t be the only jobless measure they look at when measuring the health of the economy.  

Black unemployment — which tends to fall much more slowly — might also be a factor.

I’m going to be ... pushing back against the notion that we’re all fine if the aggregate [unemployment rate] is at a certain point but some of these targeted populations are still in significant distress.

Raphael Bostic, the only Black leader of a Fed bank and a voting member on Fed policy, earlier this month

Flashback: In 2019, Powell started calling out the importance of keeping the economy humming so minority and low-income workers could reap the benefits.

Powell has said the Fed's pandemic-era policies "absolutely" will not worsen income inequality in America.

Yes, but: A study from the New York Fed this year found that easy-money policies benefited the wealthy more than lower-income people — exacerbating inequality.  

Of note: As the Fed gets louder on the importance of diversity, it's grappling with the lack of diversity in its own ranks.

The big question: Whether the sea change on climate and race is a blip or long-lasting.

"As long as the Fed is governed by reputable people, I think many of these changes are here to stay,” Adele Morris, a fellow at the Brookings Institution, tells Axios.

What to watch: Resistance from Republicans.

The latest: Sen. Pat Toomey, the top Republican on the powerful Senate Banking Committee, warned this week of "mission creep" at the Fed's regional banks, calling out their research on topics like climate change and racial justice.

2. The Fed takes on climate and race

The Fed is now pledging to tackle issues it rarely — if ever — spoke about publicly.

Photo illustration of images of a huge fire and a mural of George Floyd.

Photo illustration: Aïda Amer. Photos: Robert Gauthier (Los Angeles Times), Stephen Maturen/Getty Images

Deep Dive

Historically untouchable issues — like climate change and race — are now on the table for the Federal Reserve, as it wades further into uncharted territory. Why it matters: The about-face has implications for how one of the world’s most influential economic bodies steers policy and regulates the nation&#x27;s banks.

Not all instances of easy money cause asset-price bubbles — but all asset price bubbles for the past 250 years have been associated with loose monetary policy.  

Flashback: The first bubble to be inflated at least in part by expansive monetary policy was probably the Mississippi bubble of 1719. 

France's Banque Royal issued abundant currency to finance the purchase of shares in Compagnie des Indes, the company controlling trade in Louisiana and elsewhere.

Share prices spiked sharply, as did inflation, until John Law, who controlled the company, stopped printing money and managed to deflate the share price.

Central banks have fueled dozens of subsequent bubbles.

In fact, it's almost impossible to find a bubble since 1770 that isn't associated with lax monetary policy.

The current run-up in both stock prices and real estate has many observers diagnosing a bubble. If that's the case, it's entirely in line with previous episodes where interest rates were kept extremely low for an extended period.

The big picture: Not all bubbles end in crises, although many do — at which point the very central banks that fueled the bubble are generally tasked with cleaning up the mess. 

What they said: "The central bank cannot effectively directly target stock or other asset prices," said Fed Chair Alan Greenspan in 1999. "It is the job of economic policymakers to mitigate the fallout when it occurs and, hopefully, ease the transition to the next expansion." 

3. Everything old is new again

The run-up in stock prices and real estate has many diagnosing a bubble.

Not all instances of easy money cause asset-price bubbles — but all asset price bubbles for the past 250 years have been associated with loose monetary policy. Flashback: The first bubble to be inflated at least in part by expansive monetary policy was probably the Mississippi bubble of 1719. <ul><li>France&#x27;s Banque Royal issued abundant currency to finance the purchase of shares in Compagnie des Indes, the company controlling trade in Louisiana and elsewhere.</li><li>Share prices spiked sharply, as did inflation, until John Law, who controlled the company, stopped printing money and managed to deflate the share price.</li></ul>Central banks <a class="gtmContentClick" data-vars-link-text="have fueled" data-vars-click-url="https://scholar.princeton.edu/sites/default/files/markus/files/bubbles_centralbanks_historical_0.pdf" data-vars-content-id="a4911b0e-7e08-4995-8588-4bb6cf98d5a2" data-vars-headline="Everything old is new again" data-vars-event-category="story" data-vars-sub-category="story" data-vars-item="in_content_link" href="https://scholar.princeton.edu/sites/default/files/markus/files/bubbles_centralbanks_historical_0.pdf" target="_blank">have fueled</a> dozens of subsequent bubbles.<ul><li>In fact, it&#x27;s almost impossible to find a bubble since 1770 that isn&#x27;t associated with lax monetary policy.</li><li>The current run-up in both stock prices and real estate has many observers <a class="gtmContentClick" data-vars-link-text="diagnosing" data-vars-click-url="https://www.axios.com/stock-market-bubble-hedge-wall-street-investors-415b79aa-4149-4486-b0c4-1e5b224813b5.html" data-vars-content-id="a4911b0e-7e08-4995-8588-4bb6cf98d5a2" data-vars-headline="Everything old is new again" data-vars-event-category="story" data-vars-sub-category="story" data-vars-item="in_content_link" href="https://www.axios.com/stock-market-bubble-hedge-wall-street-investors-415b79aa-4149-4486-b0c4-1e5b224813b5.html" target="_self">diagnosing</a> a bubble. If that&#x27;s the case, it&#x27;s entirely in line with previous episodes where interest rates were kept extremely low for an extended period.</li></ul>The big picture: Not all bubbles end in crises, although many do — at which point the very central banks that fueled the bubble are generally tasked with cleaning up the mess. <ul><li>What they said: &quot;The central bank cannot effectively directly target stock or other asset prices,&quot; <a class="gtmContentClick" data-vars-link-text="said" data-vars-click-url="https://www.federalreserve.gov/boarddocs/hh/1999/july/testimony.htm" data-vars-content-id="a4911b0e-7e08-4995-8588-4bb6cf98d5a2" data-vars-headline="Everything old is new again" data-vars-event-category="story" data-vars-sub-category="story" data-vars-item="in_content_link" href="https://www.federalreserve.gov/boarddocs/hh/1999/july/testimony.htm" target="_blank">said</a> Fed Chair Alan Greenspan in 1999. &quot;It is the job of economic policymakers to mitigate the fallout when it occurs and, hopefully, ease the transition to the next expansion.&quot; </li></ul>

Data: Yardeni; Chart: Danielle Alberti/Axios

"For central banks, I don’t think there is any alternative to what they’ve been doing until now, namely vastly significantly support the economy," former European Central Bank president Mario Draghi told Axios in December. "Support, in my view, will continue for quite a long time."

4. The money spigot

economics

&quot;For central banks, I don’t think there is any alternative to what they’ve been doing until now, namely vastly significantly support the economy,&quot; former European Central Bank president Mario Draghi <a class="gtmContentClick" data-vars-link-text="told Axios in December" data-vars-click-url="https://www.axios.com/corporate-insolvency-crisis-5942d659-e4aa-4b06-bdf5-d5e97d909180.html" data-vars-content-id="e60dc4c9-07d3-4796-b059-b56422ca538d" data-vars-headline="The money spigot" data-vars-event-category="story" data-vars-sub-category="story" data-vars-item="in_content_link" href="https://www.axios.com/corporate-insolvency-crisis-5942d659-e4aa-4b06-bdf5-d5e97d909180.html" target="_self">told Axios in December</a>. &quot;Support, in my view, will continue for quite a long time.&quot;

Data:Axios/Ipsos poll; Chart: Will Chase/Axios

For all it's impact on the U.S. economy, more than three-fourths of Americans say they know "a little" or less about how the Fed operates and what it does, according to a new Ipsos poll conducted for Axios.

Why it matters: People who say they do not understand the Fed are more likely to say they don't trust what the Fed is doing. A breakdown of trust could lead to more politicization of the agency.

5. Poll: Not trusting the Fed

Lack of trust could lead to politicization

For all it&#x27;s impact on the U.S. economy, more than three-fourths of Americans say they know &quot;a little&quot; or less about how the Fed operates and what it does, according to a new Ipsos poll conducted for Axios.Why it matters: People who say they do not understand the Fed are more likely to say they don&#x27;t trust what the Fed is doing. A breakdown of trust could lead to more politicization of the agency.

Pro Rata

Axios Pro Rata

The modern Fed is designed to operate free of political pressures, as codified in a 1951 agreement with the U.S. Treasury Department. That gives monetary policy to the Fed and fiscal policy to Treasury.

Reality check: The president nominates Fed chairs and governors, who don't have lifetime appointments like Supreme Court justices, so politics has always maintained some influence.

What's changed: Former President Trump regularly blistered the Fed and Chairman Jay Powell, who was picked by Trump himself. It was unprecedented and raised concerns that Fed politicization would become the new norm.

Powell publicly brushed off Trump's attacks, but Fed monetary policy did become more Trumpian (i.e., looser), particularly in response to the pandemic.

As for determining cause and effect, we might need to wait for Powell's memoir.

President Biden appears to be honoring pre-Trump etiquette by not publicly commenting on Fed decisions.

That means any monetary politicking will be done in backrooms, likely by Treasury Secretary Janet Yellen, who was Powell's predecessor at the Fed.

Presidents usually prefer that the Fed keep interest rates low. So long as Powell remains on his current path, don't expect tensions to bubble beneath the surface. But it bears watching if monetary policy tightens, in an effort to preempt inflation.

The bottom line: Trump may have overtly politicized the Fed. But it was only temporary.

6. Biden returns to political norms on Fed decisions

Biden so far is honoring pre-Trump etiquette by not publicly commenting on Fed decisions.

Illustration of a democrat donkey and republican elephant facing each other

The modern Fed is designed to operate free of political pressures, as codified in a <a class="gtmContentClick" data-vars-link-text="1951 agreement" data-vars-click-url="https://www.richmondfed.org/publications/research/special_reports/treasury_fed_accord/" data-vars-content-id="6a605240-adbb-42b2-8b36-3a5eb80bd7bd" data-vars-headline="Biden returns to political norms on Fed decisions" data-vars-event-category="story" data-vars-sub-category="story" data-vars-item="in_content_link" href="https://www.richmondfed.org/publications/research/special_reports/treasury_fed_accord/" target="_blank">1951 agreement</a> with the U.S. Treasury Department. That gives monetary policy to the Fed and fiscal policy to Treasury.Reality check: The president nominates Fed chairs and governors, who don&#x27;t have lifetime appointments like Supreme Court justices, so politics has always maintained some influence.

President Biden has made the COVID-19 crisis and a post-Trump return to national unity and traditional democratic ideals his top priorities. From vaccinations to stimulus to schools, Biden is seeking bipartisan compromise while showing a willingness to use executive authority and bare Democratic majorities in the U.S. House and Senate to implement his policies. Republican leaders are navigating deep party divisions over if and how to move beyond former President Trump.

Politics & Policy

Federal Reserve watchers eager to know what President Biden has planned for the agency's top job will likely have to wait until at least this summer since Jerome Powell's current term as chair does not expire until early 2022. But how Biden fills other open positions on the board will offer clues about the direction he will take. 

State of play: While some say reappointing Powell is a logical choice, other reported possible picks include board member Lael Brainard or Raphael Bostic, who leads the Atlanta Fed bank.  

The big picture: The administration is considering Michigan State University economist Lisa Cook to fill an open seat that’s been vacant since Janet Yellen’s resignation in 2018 from the seven-person board, as Axios’ Hans Nichols reported in February.

Cook is considered "dovish," meaning she’s more concerned with improving employment levels and keeping interest rates low than with inflation. 

What's next: Biden will also have the opportunity to fill board member Randal Quarles’ position as vice chair of supervision when his tenure ends in October, and the president's choice could offer another clue about his bigger vision for the Fed. 

The vice chair of supervision position, created in 2010 as part of the Dodd-Frank Act, is in charge of overseeing banking but remained unfilled until Quarles' appointment in 2017.

And when Richard Clarida’s terms as both a board member and vice chair expire in January 2022, more slots will be up for grabs. 

Of course, both could be reappointed to their vice chair positions. 

The bottom line: Even without making a change at the top, Biden has a chance to steer the Fed's future.

7. Fed watchers eye Biden plans for board openings

How Biden fills open Fed board positions offers clues about the top spot.

Photo illustration of Joe Biden in a magnifying glass with lines and circles

Illustration: Eniola Odetunde/Axios. Photos: Frederic J. Brown/Getty Images

Federal Reserve watchers eager to know what President Biden has planned for the agency&#x27;s top job will likely have to wait until at least this summer since Jerome Powell&#x27;s current term as chair does not expire until early 2022. But how Biden fills other open positions on the board will offer clues about the direction he will take. State of play: While some say reappointing Powell is a logical choice, other reported <a class="gtmContentClick" data-vars-link-text="possible picks" data-vars-click-url="https://www.vox.com/future-perfect/22163440/joe-biden-fed-board-governors-build-back-better" data-vars-content-id="7abf01a3-8ef8-463c-9a41-65a0b8d6929c" data-vars-headline="Fed watchers eye Biden plans for board openings" data-vars-event-category="story" data-vars-sub-category="story" data-vars-item="in_content_link" href="https://www.vox.com/future-perfect/22163440/joe-biden-fed-board-governors-build-back-better" target="_blank">possible picks</a> include board member Lael Brainard or Raphael Bostic, who leads the Atlanta Fed bank.

The Federal Reserve has been the driving force of higher asset prices in the U.S., from stocks to housing. But now expectations are that it may begin to change course, due to inflation fears.

Axios Re:Cap goes deeper into the Fed's mission and why it matters more than ever, as part of our special Deep Dive on America's central bank.

8. Podcast: Diving deep into the Fed

Why have stocks gone up while the broadereconomy has struggled? The Fed.

Axios Re:Cap

The Federal Reserve has been the driving force of higher asset prices in the U.S., from stocks to housing. But now expectations are that it may begin to change course, due to inflation fears.Axios Re:Cap goes deeper into the Fed&#x27;s mission and why it matters more than ever, as part of our special Deep Dive on America&#x27;s central bank.<div><div><iframe frameborder="no" height="200" scrolling="no" src="https://playlist.megaphone.fm?e=AXIOS5109206659" width="100%"></iframe></div><div style="display:none"></div></div>

Podcasts

A look at the growing role of the U.S. Federal Reserve — one of the most important economic stories in the world.

The Federal Reserve's unprecedented response to the pandemic

Photo illustration of stacks of money as partial vector shapes. 

Photo illustration: Aïda Amer/Axios. Photo: Alex Wong/Getty Images