Jerome Powell's Challenge at the Fed: Keep the Economy Humming

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Janet Yellen's progress in easing the Federal Reserve away from ultralow interest rates and paring its portfolio of bonds leaves a big challenge for her successor, Jerome Powell: how to keep the U.S. economy right where it is.

Mr. Powell begins his term with the unemployment rate at 4.1%, a 17-year low, and the economy expanding at a 3% annual rate. Asset values are rising to new records, and financial conditions loosened last year even though the Fed eased its foot off the gas pedal.

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"The global economy is doing well. We're in a synchronized expansion. This is the first time in many years that we've seen this," Ms. Yellen said in her final news conference last month. "There's less to lose sleep about now than has been true for quite some time."

The top item on Mr. Powell's to-do list concerns how far and fast the Fed should raise rates. Officials voted to raise rates in December to a range between 1.25% and 2.5% and penciled in three rate increases this year, the same number as officials delivered in 2017.

For most of last year, Fed officials plowed ahead with rate increases even after inflation stayed below the central bank's 2% target. The Fed maintained that labor markets were tight enough to eventually force employers to bid up wages, which would in turn put upward pressure on prices.

If inflation were to confound expectations by staying low, the Fed would be forced to more directly confront potential flaws in its understanding of how the economy works while considering whether to delay planned rate increases. On the other hand, any sign of stronger inflation could prompt Fed officials to push for faster rate increases.

The $1.5 trillion tax cut signed into law by President Donald Trump also looms large. In the short run, giving businesses and consumers more money could spur demand for equipment, homes and other goods. In the long run, by encouraging people to work more and businesses to invest more, it could raise the economy's productive capacity by increasing the number of workers and how many goods and services they produce.

If officials conclude the tax cut is boosting demand when the economy is at or near full employment -- for example, because inflation begins rising faster -- the Fed will look to raise rates faster than planned. If it looks like the tax cut is instead increasing the economy's supply side by generating more investment, the Fed can tolerate faster growth.

Economists at Goldman Sachs Group Inc. expect the tax cuts to boost U.S. growth over the coming two years so that the unemployment rate ends this year at 3.5% before falling to 3.3% next year, a level not seen since the early 1950s.

Inflation pressures would signal the Fed has entered one of the more delicate phases of the business cycle, when the economy has reached full strength. Officials have a poor historical record managing a "soft landing," where growth eases, the unemployment rate stabilizes after falling below its equilibrium level, and the economy avoids a recession.

Mr. Powell, a lawyer and banker before he joined the Fed's board in 2012, will have to manage all this while navigating an unprecedented personnel transition on the Fed's board. He will be the first Fed chair in four decades who isn't an economist.

Though Mr. Powell isn't expected to steer policy in a different direction from Ms. Yellen, the turnover will add to potential communications challenges that confront any new Fed leader getting acclimated to the top job.

Once Mr. Powell is confirmed by the Senate and replaces Ms. Yellen as chair as soon as next month, only two officials who began 2017 on the seven-member board of governors will remain. President Trump filled his first vacant seat last year with private-equity executive Randal Quarles, the Fed's vice chair for bank supervision, and has nominated economist Marvin Goodfriend to fill a second vacancy. Once Ms. Yellen resigns her position as a governor, Mr. Trump can submit for Senate approval three more nominees this year, including the Fed's vice chair.

In addition, New York Fed President William Dudley, a permanent voter on the Fed's rate-setting committee, is also set to leave later this year. His replacement will be selected by the members of that bank's board, subject to approval by the Fed governors in Washington.

Mr. Timiraos is a reporter in The Wall Street Journal's Washington bureau. Email nick.timiraos@wsj.com.

Janet Yellen's progress in easing the Federal Reserve away from ultralow interest rates and paring its portfolio of bonds leaves a big challenge for her successor, Jerome Powell: how to keep the U.S. economy right where it is.

Mr. Powell begins his term with the unemployment rate at 4.1%, a 17-year low, and the economy expanding at a 3% annual rate. Asset values are rising to new records, and financial conditions loosened last year even though the Fed eased its foot off the gas pedal.

"The global economy is doing well. We're in a synchronized expansion. This is the first time in many years that we've seen this," Ms. Yellen said in her final news conference last month. "There's less to lose sleep about now than has been true for quite some time."

The top item on Mr. Powell's to-do list concerns how far and fast the Fed should raise rates. Officials voted to raise rates in December to a range between 1.25% and 1.5% and penciled in three rate increases this year, the same number as officials delivered in 2017.

For most of last year, Fed officials plowed ahead with rate increases even after inflation stayed below the central bank's 2% target. The Fed maintained that labor markets were tight enough to eventually force employers to bid up wages, which would in turn put upward pressure on prices.

If inflation were to confound expectations by staying low, the Fed would be forced to more directly confront potential flaws in its understanding of how the economy works while considering whether to delay planned rate increases. On the other hand, any sign of stronger inflation could prompt Fed officials to push for faster rate increases.

The $1.5 trillion tax cut signed into law by President Donald Trump also looms large. In the short run, giving businesses and consumers more money could spur demand for equipment, homes and other goods. In the long run, by encouraging people to work more and businesses to invest more, it could raise the economy's productive capacity by increasing the number of workers and how many goods and services they produce.

If officials conclude the tax cut is boosting demand when the economy is at or near full employment -- for example, because inflation begins rising faster -- the Fed will look to raise rates faster than planned. If it looks like the tax cut is instead increasing the economy's supply side by generating more investment, the Fed can tolerate faster growth.

Economists at Goldman Sachs Group Inc. expect the tax cuts to boost U.S. growth over the coming two years so that the unemployment rate ends this year at 3.5% before falling to 3.3% next year, a level not seen since the early 1950s.

Inflation pressures would signal the Fed has entered one of the more delicate phases of the business cycle, when the economy has reached full strength. Officials have a poor historical record managing a "soft landing," where growth eases, the unemployment rate stabilizes after falling below its equilibrium level, and the economy avoids a recession.

Mr. Powell, a lawyer and banker before he joined the Fed's board in 2012, will have to manage all this while navigating an unprecedented personnel transition on the Fed's board. He will be the first Fed chair in four decades who isn't an economist.

Though Mr. Powell isn't expected to steer policy in a different direction from Ms. Yellen, the turnover will add to potential communications challenges that confront any new Fed leader getting acclimated to the top job.

Once Mr. Powell is confirmed by the Senate and replaces Ms. Yellen as chair as soon as next month, only two officials who began 2017 on the seven-member board of governors will remain. President Trump filled his first vacant seat last year with private-equity executive Randal Quarles, the Fed's vice chair for bank supervision, and has nominated economist Marvin Goodfriend to fill a second vacancy. Once Ms. Yellen resigns her position as a governor, Mr. Trump can submit for Senate approval three more nominees this year, including the Fed's vice chair.

In addition, New York Fed President William Dudley, a permanent voter on the Fed's rate-setting committee, is also set to leave later this year. His replacement will be selected by the members of that bank's board, subject to approval by the Fed governors in Washington.

Mr. Timiraos is a reporter in The Wall Street Journal's Washington bureau. Email nick.timiraos@wsj.com.

Corrections & Amplifications

This article was corrected Jan. 22, 2018 at 8:01 a.m. ET because it incorrectly stated that rates rose to a range between 1.25% and 2.5%. Fed officials voted to raise rates in December to a range between 1.25% and 1.5%.

The article "Jerome Powell's Challenge at the Fed: Keep the Economy Humming," which ran at 1:19 p.m. ET on Monday, incorrectly stated that rates rose to a range between 1.25% and 2.5%. Fed officials voted to raise rates in December to a range between 1.25% and 1.5%. Jan. 23, 2018

(END) Dow Jones Newswires

January 23, 2018 08:09 ET (13:09 GMT)

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