The Federal Reserve' s Shadow Government

Powell’s shadow Fed majority could threaten jobs, housing and growth

Jay Powell lost the chairmanship. He may still control the reaction function

PETER NAVARRO: Kevin Warsh has now been sworn in as the new Federal Reserve chair. Outgoing Chair Jerome Powell has refused to leave the Fed Board of Governors, breaking with the modern custom that departing Fed chairs leave the Board rather than linger as rival power centers.

The clear danger: Powell will have enough board support to act as Fed shadow chair and force a series of rate hikes down Warsh’s throat.

Never mind that even a single rate hike would be the worst possible response to an oil-price shock. Never mind that two of Jay Powell’s predecessors understood the difference between demand inflation and an oil shock.

When Iraq invaded Kuwait in 1990, Alan Greenspan understood that an oil shock can both raise headline inflation and damage growth. His FOMC repeatedly cut the federal-funds rate as the economy weakened.

When oil, foodstuffs, fertilizers and industrial metals all moved sharply higher in 2008 — driven by booming emerging-market demand, constrained supply, thin spare capacity and speculative flows — Ben Bernanke’s Fed likewise cut the federal-funds rate in April. He then held steady in June and refused to launch a recessionary rate-hike campaign into prices the Fed could not drill, refine, mine, plant or ship away.

That is the looming central error. The Fed cannot produce one extra barrel of oil. It cannot reopen a shipping lane. It cannot refine gasoline. It cannot lower diesel costs by crushing mortgage demand in Ohio or forcing a small manufacturer in Pennsylvania to roll over credit at punitive rates.

A Fed rate hike now would rein in demand in response to a supply shock and hit precisely where the economy is already vulnerable. Housing would weaken further. Interest-sensitive manufacturing would suffer.

Small-business credit would tighten. Financial conditions would tighten just as energy prices are eating real incomes. The dollar could strengthen, pressuring exporters.

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