The term “regime change” is currently trending in the headlines, from “More expect Venezuela will collapse and have regime change within 12 months” to “Pushing back against Iran: Is it time for regime change?” As we enter the second quarter of 2018, however, the term is increasingly used to describe a subtle but equally important shift in economic policy. Monetary policy stands out as a significant economic catalyst, and with the departure of Federal Reserve Chair Janet Yellen, we’ve seen headlines blare: “How to survive the regime change in markets.”
Referring to February’s market correction, triggered by fears that inflation was beginning to assert itself, the Financial Times succinctly stated: “Whether correction turns into regime change is down to the Fed.” But do members of the Federal Open Market Committee (FOMC) of the Federal Reserve view their job as protectors of stock market performance, the way they seemingly did coming out of the financial crisis?
Newly installed Fed Chairman Jerome Powell, greeted on his first official day with a 4 percent market sell-off, appeared upbeat about prospects for the economy. “We don’t manage the stock market, but it enters into our thinking,” he testified on Capitol Hill at the end of February. “The stock market is not the economy, but it is very much a factor in the economy’s overall performance.”
As a Federal Reserve governor, Powell spoke at a 2017 meeting of the American Finance Association and observed that low interest rates can lead to “excessive leverage and broadly unsustainable asset prices.” He added that if risk taking doesn’t result in financial instability, it is not the “Fed’s job to stop people from losing, or making, money.”
Now that Fed Governor Powell is Chairman Powell, he is taking monetary policy towards normalization, while markets hope it’s not toward premature tightening.
SIGNIFICANT REGIME CHANGES AT THE FED
G. William Miller: Feeds Inflation
It wasn’t that long ago when inflation surged under the Fed chairmanship of G. William Miller (1978 – 1979), appointed by President Carter. A lawyer by training, he took office when the economy was already showing signs of rising inflationary pressures, but Miller was hesitant to raise rates.
The U.S. dollar lost 42 percent against the Japanese yen and over 30 percent against the German mark, and stagflation took hold. Stagflation is the unfortunate combination of a stagnating economy—high unemployment, low demand—engulfed by rising inflation, which had reached 14 percent by early 1980.
Last year, following the appointment of Jerome Powell—also a lawyer rather than a Ph.D. economist—critics pointed to Miller’s tenure, which the Financial Times termed a “disaster.”
Paul Volcker: Slays Inflation
Miller was followed by Paul Volcker (1979 – 1987), who is credited with bringing inflation under control. According to a 2015 interview, President Jimmy Carter was advised that Volcker, the president of the New York Federal Reserve, would be a mistake. “They knew that if I appointed him, he would institute the tough medicine of tight monetary policy, which would be difficult for the economy in the short run,” Carter said.