The Capitol Hill testimonies that began this morning by Federal Reserve Chairman Jerome Powell and outgoing Treasury Secretary Steven Mnuchin will undoubtedly put the rare rift between the Fed and Treasury over the Fed’s 13-3 facilities back into the political limelight. But for us the two days of testimonies may also provide an early glimpse into the potential areas of policy cooperation – and inevitable institutional tensions – between Powell and incoming Treasury Secretary Janet Yellen, the former Fed Chair.
*** First, on the 13-3 facilities, for all the sound and fury over Secretary Mnuchin’s decision to wind down the bulk of the joint programs, we think it unlikely Secretary Yellen will use valuable political capital to seek renewed congressional funding. After all, economic and market conditions may never deteriorate to such a darkening degree that Congress is frightened back into another rush of funding. And Treasury can also tap its Exchange Stabilization Funds to capitalize any new or extended 13-3 Special Purpose Vehicles. What’s more, if the “found money” of the uncommitted CARES Act funding is “returned” to Congress and it helps to boost the probabilities and size of a revived stimulus bill before Congress adjourns, so much the better. ***
*** But beyond the 13-3 debate, the long, close working relationship and shared policy views between Powell and Yellen will play out next year on several other major fronts. The most public will be the shared ambitions for an expansive fiscal policy that Yellen will be taking the lead in advocating to Congress. In contrast to the Fed’s prior wariness over expansive fiscal policies and large deficits for fear of inflationary pressures, Fed officials including Powell have been strongly pleading for a more aggressive near term fiscal policy. That means the two most powerful US economic policymakers will be pushing in the same broad direction on fiscal policy, a rare joint-effort in the post-war period, which the markets are likely to be closely monitoring. ***
*** In addition, there is very likely to be an intensified but less visible cooperation if not coordination between the Fed and Treasury over Treasury’s debt management policies and the Fed’s balance sheet policy. The scale of Treasury’s new debt issuance and where on the curve it will be issued will be critical factors in the Fed’s decisions on whether and when to alter either the pace or composition of its current $80 billion a month in treasury purchases. In addition, by the middle of next year Congress will need to pass another increase in the federal debt ceiling. Treasury will be carefully managing its debt issuance and the balances in its cash account at the Fed in the run up to that vote, while the Fed will be keeping an eye on spillover effects on the level of excess reserves in the banking system. ***
*** In each case, the common ground between Yellen and Powell will be invaluable, but invariably put to the test: on fiscal policy for instance, the Fed is unlikely to go much beyond a general support for a more activist fiscal policy to take the lead in bridging the massive demand and income shortfall that continues to hobble a still fragile economic recovery. There may also be differences over the next steps in the regulation of the banks and the financial system. Indeed, there are likely to be almost inevitable tensions in the institutional differences over fiscal dominance and the Fed’s operational independence, especially if the economy takes a turn for the worse, with increased political demands on the Fed’s balance sheet. ***
Navigating Fiscal Policy Through Congress
There will be plenty on Secretary Yellen’s plate from day one, and she will be bringing a long list of skills, and a deep thirty years of policy experience to the challenges ahead. Her formal nomination by President-elect Biden yesterday was met with praise across Capitol Hill, including by influential Republicans. By any measure, she will be easily confirmed by the Senate.
Her immediate challenge that will be most closely watched by the markets will be in shaping and selling the Biden Administration’s fiscal policy ambitions. The pragmatic and always methodically prepared incoming Treasury Secretary will bring a formidable intellectual rigor to the case for an expansive fiscal policy to drive towards a full employment, higher wage, more balanced economy. Her long track record of consensus building will certainly be put to the test in seeking to win over at least a handful of Senate Republicans on an aggressive fiscal policy when renewed concerns over the size of federal deficits are already resurfacing. She will also invariably need to beat back even more aggressively expansive fiscal demands by progressive Democrats.
Yellen’s fiscal policy navigation between reluctant Senate Republicans and impatient House Democrats will be uniquely bolstered by the Fed’s embrace of a high pressure economy in its new policy framework. Its formal adoption earlier this year was very much the outcome to Chairman Jerome Powell’s own evolution in thinking and Committee consensus building, but its roots richly lie in the direction Yellen drove the FOMC during her tenure as chair.
Indeed, the next year or more is very likely to see a period of intense policy activism to lift the pandemic-scarred economy back to a full employment, debt sustainable pace of real growth. It will invariably require a level of cooperation if not coordination between fiscal and monetary policy not seen in the US since perhaps the pre-Accord financing of the Second World War.
That will be apparent from the start of the Biden Administration when the scale of its fiscal policy ambitions come into view. Yellen has already sounded the alarm to avoid the fiscal policy mistakes in the 2011-2013 period when the then Tea Party-dominated Republican Party forced a fiscal pullback just when the still fragile recovery from the 2008-2009 Great Financial Crisis was shy of a much-prized “escape velocity,” and a long period of low growth followed. “Now is not the time to have fiscal policy switch from being accommodative to creating a drag,” Yellen recently remarked.
But the origins of the current economic weakness are not the same as when the GFC savaged the economy, and despite the exponential acceleration of the Covid virus across the country going into the year-end, next year should see the promise of widely available vaccines and a burst of repressed spending that may limit the need for an extended fiscal “bridge” to plug the massive demand shortfall since spring. It will remain to be seen whether either an additional supplementary fiscal package will be needed in the opening weeks of the Biden first year, or even just how expansive a FY2022 budget will be politically viable if the economy is bouncing back.
Fed officials across the FOMC, including Chairman Powell, have pleaded the case for an expansive near term fiscal policy as the primary, first driver to a stronger aggregate demand-driven growth that will, in turn, allow for a more effective and balanced monetary policy. As we wrote earlier (SGH 11/23/20, “Fed: The Minutes and the December Meeting”), the more muscular the fiscal policy in the coming months, the more likely there will be an aggressive Fed balance sheet policy to extend a period of accommodative financial conditions.
That, to a degree, will work in Secretary Yellen’s favor in adding some institutional heft to the arguments on Capitol Hill for a more aggressive fiscal policy and in winning over moderate Republicans to make the legislative difference.
But the Fed’s endorsements on the fiscal policy front will never be as vocal or as specific as Yellen or Democrats will want and need – Chairman Powell will probably make that apparent in only going so far in his twin testimonies on the CARES bill this week – and indeed both the Fed chairman and the incoming Treasury Secretary will get uncomfortable if the fiscal plans don’t include sunset or tax policies to begin trimming the scale of the projected deficits in the latter years of the ten year baseline.
Cooperation on Debt Management, and the Debt Ceiling
But where the nexus between Secretary Yellen and Chairman Powell and, institutionally, between Treasury and the Fed, may be uniquely needed is some degree of cooperation on the Treasury’s debt management strategy; at what maturities Treasury intends to issue its debt will obviously define much of the shape of the yield curve, and it will also be a critical factor in the eventual FOMC decision on its asset purchases policy, and how effective the asset purchases could prove to be.
The degree of cooperation may not rise to that of a formal “new Accord” to define the lines of responsibility and powers between Treasury and the Fed, but there is certain to be a “sharing” of views on QE and debt management strategy in the weekly meetings between the Secretary and Chairman. There is also likely to be staff-level cooperation on Treasury’s debt management plans.
And while not wishing to overstate the point, as we recently noted (SGH 11/25/20, “Fed: “If Appropriate”), we suspect one of the reasons the Federal Open Market Committee may pass at their December meeting on committing to a shift in the pace or composition of its current asset purchases will be to wait for greater clarity on the scope and scale, and political probabilities, of the Biden Administration’s fiscal ambitions next year.
What’s more, a sense of the Treasury’s debt management strategy is also not just in the medium term timeline of the overall budget tax and spending policies, but in Treasury’s nearer term management of its short debt issuance and cash management going into when, at some point, probably next summer, Congress will need to pass another increase the federal debt ceiling.
The approach of the deadline, and the need for Treasury to bring its cash balances back to where they were at the point of the last debt ceiling increase will inevitably entail some careful management of bills issuance and the cash in the Treasury’s General Account held at the Fed and that, in turn, will affect the level of the excess reserves the Fed places with the commercial banks. It is far too early to say how and when exactly this will play out, but it will be a policy priority and an issue on the market radar screen by spring.
Bank Regulation and Those 13-3 Facilities
Another area that will see a close cooperation between the Treasury and the Fed will be over financial regulation. There will be particularly intense political lobbying by progressive Democrats to maintain or add to the level of regulatory requirements under the Dodd-Frank legislation. Yellen, from her perch at Brookings after she left the Fed, had indicated her opposition to the Trump Administration efforts to loosen up some of regulatory requirements imposed on the banks, which also saw a sign-off by the Feds Board of Governors save for the lone protest no vote by Governor Lael Brainard.
Yellen has also shifted somewhat in her views towards greater financial stability concerns that are already being sounded by several FOMC members, especially among a handful of the District Presidents. Treasury is pretty much at the forefront of the Financial Stability Oversight Council, which was somewhat shunted to the side during the Trump years, and so there is likely to be a halt to further loosening of the regulatory demands on the big banks, as well as new policies to rein in alleged excesses in the non-bank sector.
But that said, the efforts to bring a greater resilience to the non-bank financial system, and to diminish the financial system tail risk for taxpayers will be tricky political navigation for both Secretary Yellen and Chairman Powell in that if for any other reason, the Fed will have to soon address the potential “crowding out” on commercial bank balance sheets in the ever expanding funding of its asset purchase through excess reserves placed with the banks. We noted the issue in a recent report (see SGH 10/16/20, “Fed: Where This is Heading”), and several participants at the November FOMC meeting also raised the issue, according to the Minutes .
And on one last point to add on the future status of the Fed’s 13-3 emergency credit facilities: For now, we think it more likely than not that if economic and market conditions do worsen significantly after the Biden Administration assumes power, Treasury will draw on its full authority to utilize its $75 billion or so in the Exchange Stabilization Fund rather than rush to Capitol Hill for renewed 13-3 funding. Secretary Yellen would be able to quickly commit the $20 billion or so in the dollar-denominated ESF funds to re-capitalize reinstituted 13-3 Special Purpose Vehicles, which would, in turn, be leveraged to whatever level deemed appropriate.
And if more funding is needed to support the 13-3 facilities, while the FOMC as a general rule is loath to do so in the case of foreign exchange interventions, the Fed could “warehouse” Treasury’s non-dollar ESF holdings by swapping out the foreign currencies for dollars to make the full ESF funding available. But that in fact could be another on the list of potential tension points between the two institutions.