BARACK OBAMA’S economic record was overshadowed by a torturously slow recovery from the global financial crisis. A premature turn to deficit-reduction left America’s recovery in the hands of a Federal Reserve that was doctrinally unprepared to engineer a rapid rebound in employment. Mr Obama’s vice-president, and now the president-elect, Joe Biden, no doubt took the lessons of that experience to heart. Ahead of America’s presidential election, he seemed poised to meet the pandemic-induced downturn with fiscal force. If the Democratic Party does not win a Senate majority, however, an all-too-familiar mess might ensue. With generous fiscal support seemingly off the cards, the central bank may again prove ill-equipped to rise to the challenge of providing needed stimulus. And Mr Biden may struggle to place his stamp on the Fed’s board of governors. The drama surrounding the nomination of Judy Shelton, a Republican pick with outlandish economic views, which on November 17th stumbled after it appeared she had insufficient support in the Senate, could become the first of many.
Central banks once required little in the way of fiscal assistance. But they have struggled to cope since a drop in short-term interest rates towards zero sapped their preferred policy response of its potency. None has dared to cut rates deep into negative territory, fearing the potential risks to banking systems. Massive asset-purchase programmes have provided a modest fillip to demand, and central bankers in Asia and Europe continue to experiment with new tools, by expanding their purchases beyond government bonds and setting caps on long-term interest rates, for instance. Nonetheless, diminished monetary ammunition has led economists to advocate that fiscal policy play a much larger role in stabilising the economy.
The Fed has tried to adjust to this new world. In the wake of the financial crisis it promised to keep interest rates “at exceptionally low levels…for an extended period”. But that failed to spark a rapid recovery. Perhaps the public doubted that the Fed would actually keep rates low, and tolerate the resulting faster price growth, when the time came. The Fed’s promise may well have been undermined by its framework, which stipulated an inflation target of 2%. The need for a new approach—one that would explicitly enable the Fed to accept higher inflation, and so keep interest rates low for longer—led Jerome Powell, its chairman, to launch a strategy review in 2019. In August this year he unveiled a revised framework, one of “average-inflation targeting”. Its premise is simple. If the Fed wants to hit its 2% target on average, then periods of below-target inflation, which are expected to be numerous in coming years, must be offset by corresponding periods of above-target inflation. The Fed was giving itself permission not to slam the economic brakes (by raising interest rates) should inflation threaten to rise above 2%.
A promise not to brake, though, cannot get a stalled car moving. The Fed did not pair its new strategy with other demand-boosting measures. It bought roughly $3trn in assets between February and June, as covid-19 sent the economy into a tailspin, but has since kept its balance-sheet roughly flat. The Fed’s new doveishness looks to be opportunistic rather than active: it will accept higher inflation should someone else kick the economy in that direction, but is reluctant to try new monetary measures to deliver a kick of its own. That might explain why market expectations of inflation in ten years’ time remain well below pre-pandemic levels and have changed little since the summer.
It seems that, like Mr Biden, Mr Powell placed his hopes in fiscal stimulus. The chairman has repeatedly urged Congress to provide more support to America’s pandemic-stricken economy. Now, though, Democrats must win two difficult run-off races in January to keep the Senate out of the hands of Republicans, who are unlikely to facilitate Mr Biden’s policies. (A Republican Senate would continue to be led by Mitch McConnell, who said in 2010 that limiting Mr Obama to one presidential term was his party’s top priority.) Mr Biden’s grand economic plans thus look doomed, shifting chief responsibility for America’s economic fortunes back to the central bank. Passive doveishness alone may not suffice.
The Fed will do its best to respond. It may soon approve more monetary stimulus in response to a new covid-induced economic chill; in a speech on November 16th Richard Clarida, the Fed’s vice-chairman, hinted that an expanded asset-purchase programme could be in the offing. But the opportunity to pair new measures with an attention-grabbing policy overhaul has passed. A revision to its strategy just months after the last one would undermine the central bank’s credibility.
A change in its leadership could give the Fed an opportunity to adjust its message and tactics. But Mr Biden will not find it easy to remould the central bank. Mr Powell’s term as chairman does not expire until 2022. His decent record means that Mr Biden is unlikely to depart from the custom of renewing a sitting chairman’s term (it is one that President Donald Trump departed from when he did not reappoint Janet Yellen, Mr Powell’s predecessor). Nor is it clear that a Republican Senate would approve Mr Biden’s nominees, which could soon become a problem if Lael Brainard, a doveish Fed governor who is considered to be one of the front-runners to be Mr Biden’s treasury secretary, vacates her seat. In 2011 the Republicans blocked Mr Obama’s choice of Peter Diamond, a Nobel-prizewinning economist, and monetary policy has only become more political since. Mr McConnell is continuing to hunt for votes among a quarantine-depleted Republican caucus to approve Ms Shelton’s nomination. Mr Biden may find that economic ideas have changed since he last walked the corridors of power. Politics has not.