Hawks vs doves: US Federal Reserve divided over when to dial back economic support

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Jay Powell, the chair of the Federal Reserve, is facing a growing rift among top officials at the US central bank over when to start withdrawing the huge injection of monetary stimulus that was deployed at the onset of the pandemic.

At the start of the Covid-19 crisis, central bankers were united on the need to stave off economic meltdown by keeping interest rates at rock bottom lows while also buying $120bn of assets each month. But with the US economy rebounding after pandemic-era restrictions were lifted — leading to a sharp burst of inflation — the debate over when to start scaling back the bond-buying programme has intensified.

The conversation on when to taper the asset purchases — a precursor to eventual interest rate rises — kicked off last month and is expected to escalate at the Federal Open Market Committee meeting on Tuesday and Wednesday.

Powell must find a middle ground between central bankers who are pushing for an earlier, more aggressive retreat and those who are wary of a rapid shift in policy. If the Fed chooses a more cautious approach, asset tapering may not occur until early 2022; but if it feels the need to act with greater urgency, it could move in the autumn. 

Here are the different camps within the Fed as it prepares for a big pivot in monetary policy. Powell is somewhere in-between, tilting towards the doves, but other Fed officials have more hawkish leanings.

The doves

Clockwise from top left: Lael Brainard, Mary Daly, Michelle Bowman, John Williams, Neel Kashkari and Charles Evans © FT montage; Bloomberg, Getty Images

The dovish contingent at the Fed maintains that it is too early to consider pulling back policy support with nearly 7m people still out of work compared with last February. They believe that inflationary pressures will fade over time and worry about the fragility of the US economy, given the alarming spread of the Delta virus variant as well as low vaccination rates in several Republican states and across large swaths of the world. 

Neel Kashkari of the Minneapolis Fed, who is not a voting member of the committee until 2023, is among the most dovish. In an interview with Reuters in June, he made a case for the central bank to keep its bond buying at full blast until the outlook becomes much clearer, and tethering interest rates at near zero until at least the end of 2023 in order to “really achieve maximum employment”.

Governor Michelle Bowman, who votes at each meeting, has taken a similar stance, highlighting the vast economic disparities disproportionately affecting low-income workers and people of colour, which she says holds back progress towards reaching maximum employment.

Lael Brainard, another governor, and John Williams, president of the New York Fed branch — both voters — have thrown their support behind these views too.

Mary Daly, president of the San Francisco Fed and in the dovish camp, recently told the Financial Times that disagreements at the central bank were natural at this stage.

“Turning points, by definition, are hard,” she said earlier this month. “You’ve got some incoming data that look good. You’ve got risks that still remain . . . and you’ve got people in different parts of the country or looking just through different lenses, all coming to the table.”

The hawks

Clockwise from top left: Raphael Bostic, James Bullard, Esther George, Eric Rosengren, Robert Kaplan and Patrick Harker

Hawkish Fed officials caution against dismissing high inflation data too easily, especially after the latest batch not only showed consumer prices lurching up at the fastest pace since 2008 but also pressures broadening out beyond transitory factors such as the cost of used cars.

The hawks expect inflation — as measured by the central bank’s favourite gauge, the core personal consumption expenditures price index — to run well above the Fed’s longstanding 2 per cent target this year and next, necessitating an earlier tightening of monetary policy than their dovish counterparts want.

They fear the Fed risks being caught off guard if price increases do become entrenched, which would force the central bank to intervene more abruptly and aggressively to tighten policy later on — a more disruptive move for the economy and financial markets.

Robert Kaplan, president of the Dallas Fed and one of the most vocal constituents of this camp, has strongly advocated for the central bank to begin dialling down its bond buying soon.

He is also a chief proponent of rapid the scaling back of mortgage-backed securities purchases, on the grounds that they are adding unnecessary fuel to the booming housing market. Indeed, more hawkish officials who advocate for an earlier tapering often point to financial stability concerns as a reason to act sooner rather than later.

The centrists

Clockwise from top left: Randal Quarles, Tom Barkin, Richard Clarida, Loretta Mester, Jay Powell and Christopher Waller

The centrists at the Fed simultaneously acknowledge the strength of the economic rebound and the inflationary overshoot, as well as the uncertainty of the outlook and the risk of another Covid-related pullback in activity.

They also stress that they will be flexible depending on how the data look over the coming months, given that there are risks developing on both sides of the economic argument.

They are less convinced about the need to scale back the Fed’s support immediately but do accept that the conditions will soon be met to begin making adjustments, albeit at a very gradual and well-telegraphed pace.

Leadership at the Fed is largely aligned with this view: Powell is on the more dovish side of the centrist spectrum, as is Richard Clarida, the vice-chair, while Randal Quarles, the vice-chair for supervision, may be slightly more keen on moving ahead with tapering, according to Fed watchers.

“It would be a mistake to act prematurely,” Powell said during a recent congressional hearing. “One way or the other, we are not going to be going into a period of high inflation for a long period of time, because of course we have tools to address that. But we don’t want to use them in a way that is unnecessary or that interrupts the rebound of the economy.”

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