By the Bloomberg editorial team
Federal Reserve Chairman Jerome Powell said last week that he intends to remain on the central bank's board of directors after his term expires on May 15 — unless the Justice Department "definitively and transparently" concludes the criminal investigation into the Fed's headquarters renovation work.
Powell's decision is unusual and, as he no doubt realizes, it will come at a cost. It is also fully justified.
Powell's successor to the position of chairman has almost been decided, after the Senate Banking Affairs Committee voted to advance the nomination of Kevin Warsh. However, Powell's tenure as one of the Fed's seven governors is separate and runs until 2028. Typically, an outgoing president resigns from both positions, as Powell states he intended to do. By remaining on the board, it prevents the appointment of a new commander, which gives the White House an incentive to declare that it has abandoned, and not simply suspended, the investigation.
Since the investigation was problematic from the start, that is exactly what should have happened. Instead of a bona fide investigation into any irregularities, it was widely seen as an attempt to intimidate Powell and his colleagues into lowering interest rates, as the government had demanded. It was a frontal attack on central bank independence, as Powell has stated. The threat has since been mitigated, but it has not been eliminated. The Justice Department has said it intends to halt its investigation and refer it to the Fed's inspector general, but the current administration doesn't exactly have a reputation for keeping its word.
The Fed's independence is essential for sound monetary policy — a point on which Powell, Wars and every other competent central banker agree. Once it is assumed that policy plans affect the interest rate, the risk of higher inflation increases. Higher inflation in turn raises long-term interest rates, which makes loans more expensive, counteracts the effort to stimulate demand, and then leads to more inflation. Subordinating monetary policy to politics is a tried and tested recipe for failure.
Admittedly, Powell's stay on the board comes at a cost. As long as he's there, investors and analysts will be looking for signs of disagreement and confrontation. They will worry that a dispute over who is really in control will distract Fed policymakers from their real role — which could indeed happen. Warsh's task of taking on a leadership role and guiding his colleagues as a leader will be more difficult.
A cleaner exit would be better — but the commitment to central bank independence matters more. Of course, even if the government backs down now to hasten Powell's departure, it may resume its efforts to intimidate the central bank in the future. Fed policymakers cannot fully resist these kinds of pressures. However, Powell is right to seek a solution – as much as he can. If the government were to think wiser, it would see that such an outcome serves its own purposes, avoiding financial instability and making it easier for the Fed to cut interest rates as soon as economic conditions allow.
By using his influence to persuade the Justice Department to back down, Powell is serving the public interest. Warsh will soon take office. The White House should declare victory and back down.
BloombergOpinion
