Powell faces early test of policy view as tax cuts near approval

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WASHINGTON, Dec 11 – Incoming Federal Reserve
chair Jerome Powell, chosen by U.S. President Donald Trump to
keep the recovery humming, appears set to let an expected
trillion=dollar tax cut run its course through the economy as
weak wage growth and inflation buttress his view that the
economy remains underpowered.

Powell in statements throughout the year, culminating with
his recent Senate confirmation hearing, has been clear he sees
little risk of inflation that would prompt the Fed to raise
rates faster than expected, and takes weak wage growth as a sign
that side-lined workers remain to be drawn into jobs.

New data added evidence to that view on Friday. Employment
in November grew faster than expected, but wage growth remained
muted. The share of working age adults with jobs continued a
steady, six-year recovery that is approaching its pre-crisis
peak.

Even with the unemployment rate at a 17-year low of 4.1
percent, “there’s no sense of an overheating economy or a
particularly tight labour market,” Powell told members of the
Senate Banking Committee, saying that the Fed should raise rates
only gradually.

Debate among Powell’s colleagues, meanwhile, has highlighted
other risks if the Fed speeds its pace of rate increases.

Some policymakers feel the central bank has already undercut
its credibility by raising interest rates while inflation
remains so weak. Others have noted that if the Fed continues
raising short-term rates while long-term rates remain stalled,
it could turn the shape of the bond yield curve upside down, a
typical signal of recession.

“If the Fed gets its paradigm wrong and sees inflation that
ultimately doesn’t materialize, and they take rates too far,
then markets would feel aggrieved,” said Carl Tannenbaum, chief
economist at Northern Trust in Chicago, and a former senior risk
official at the Fed Board.

Other analysts are starting to see a potential dovish
surprise when Powell takes over in February, the tax cuts could
kick in, and the Fed stands aside.

“MORE DOVISH FED”

With a background as an investment banker rather than as an
economist rooted in a particular analytical framework, Powell
will lead “a more data-driven Fed, which at the current juncture
means a more dovish Fed,” until and if inflation recovers, said
Robin Brooks, chief economist at the Institute of International
Finance.

He expects the Fed under Powell to only raise rates twice
next year.

Policymakers will give an initial reading on the impact of
the Republican tax plan when they meet next week. They are
expected to raise interest rates for the third time this year.
They will also update their economic and interest rate
projections for 2018 and beyond, the first such forecasts since
the outlines of the tax overhaul became clear.

Top Republicans from the House and the Senate are rushing to
complete negotiations to push the tax plan into law.

Though Janet Yellen remains Fed chair until February, her
final scheduled press conference on Wednesday afternoon will set
the policy backdrop Powell inherits. The 64-year-old lawyer will
attend the meeting as a sitting governor, and help shape the
statement issued that day by the Federal Open Market Committee.

It is a group struggling with a fundamental issue.

The economy is arguably as much as a half a percentage point
below full employment, a condition in which prices and wages
should be rising. Yet both remain weak.

Into that mix, the tax cut legislation would put tens of
billions of dollars back in the hands of corporations and
households.

If there is still “slack” in the economy, that could produce
faster real growth as spending and investment increase, and more
workers are hired. However, if the economy is near or above its
potential, as some measures indicate, it may merely cause
faster-than-desired price increases, or a jump in stock and
other asset values that raise concerns of a bubble.

As the tax plan advanced in Congress, forecasting shops at
Goldman Sachs, JP Morgan and others penciled in a faster pace of
Fed rate increases – essentially expecting the Fed would need to
lean against the inflationary outcome.

The tax package is “ultimately worth almost two additional
Fed hikes” in coming years, Goldman Sachs economists David
Mericle and Alec Phillips wrote in a recent analysis.

But the new chair’s own public speeches and comments
throughout the past year have shown an evolving faith that the
Fed’s go-slow approach can continue, giving more time for
workers to rebound from the 2007-2009 crisis without creating
other economic risks.

“Accommodative policy did not generate high inflation or
excessive credit growth; rather, it helped restore full
employment,” Powell said in June in his last extensive speech on
monetary policy before he emerged as a contender for the top Fed
job.

His outlook is consistent with positions Trump and current
chair Janet Yellen have taken, and the depth of his commitment
to that view will be a critical part of the Fed’s debate about
whether and how to react to the tax plan.

At his confirmation hearing, Powell avoided any direct
critique or endorsement of the pending legislation, telling
lawmakers fiscal policy was their domain.

But when asked about Fed staff research that challenged a
key Republican premise that corporate tax cuts generate jobs,
Powell kept his distance.

“It’s just someone’s research,” Powell told senators. “Don’t
associate that with a position of the board.”

-(Reuters)