Edward Lotterman
The Federal Reserve has gotten lots of media attention recently, notwithstanding everything else that’s happening in the world.
Consider the following news items in from the past week:
• Fed Governors Michelle Bowman and Christopher Waller spoke in favor of lowering the Fed’s interest rate target — immediately.
• In his inimitable style, President Donald Trump came up with new nasty adjectives to describe Fed Chair Jerome Powell — who has the temerity to be willing to wait to lower rates until the data actually call for it.
• Powell’s semi-annual Humphrey-Hawkins report to Congress stretched over three days and included testy questions by multiple senators and representatives.
• The Fed announced it would loosen reserve requirements imposed on large banks in the 2007-09 financial debacle.
• Fed Governor Michael Barr bluntly asserted, “I expect inflation to rise due to tariffs,” in calling for no change in interest rates.
• While speaking before Congress, Powell was forced to explain a large cost overrun in remodeling the Fed’s 90-year-old primary D.C. headquarters building.
What to make of all of this?
Start by backing off the details to review fundamentals:
Contrary to what the media, general public and many politicians may think, a Fed Board Chair is not a dictator. They cannot make unilateral decisions on the money supply and thus interest rates. These fall to a 19-person Federal Open-Market Committee that meets eight times a year. The committee consists of the seven governors appointed by presidents and confirmed by the Senate, together with the presidents of the 12 Fed District Banks.
These independent banks are individual private corporations who hire their own executives. Neither the president nor Congress have any say over their ongoing operations.
All 19 members participate in discussions, but when time comes for a vote, only five of the 12 district presidents vote in an annual rotation. Minneapolis Fed President Neel Kashkari does not vote this year, but will in 2026 and again in 2029.
The vote is on a motion by the chair for monetary policy to follow until the next meeting — either in increasing or decreasing the money supply via the buying and selling of government bonds in the “open market.” This then determines the interest rate that Trump wants Powell to lower.
The motion always passes, but only because a chair never makes a motion that would cause a bad split. One or two dissents by district presidents are not uncommon. Three or more are. And dissents by other governors are rare indeed.
The reason is that the seven governors work in the same building and can hammer out differences behind closed doors. Differences may be accommodated in the wording of the “FOMC Statements” released to the press after meetings. Open splits are avoided since they might panic financial markets.
If any of the 12 district presidents meet between FOMC meetings, it is only incidentally. There is an unwritten rule that they not caucus between meetings. All give public speeches frequently. They communicate their personal views to each other via bland statements in these speeches. When voting members, they can dissent at any meeting. But frequent dissents soon devalue one’s message. In the 1990s, Cleveland Fed Bank President Jerry Jordan dissented so frequently that he was largely ignored.
So now two governors, Bowman and Waller, very openly oppose the chair. While not unprecedented, this is highly unusual, especially only days after a meeting in which all had agreed to make no changes to rates.
It means nothing that the dissenters were appointed by Trump in his first term (as was Powell). Given their backgrounds, it is highly likely Bowman and Waller detest Trump’s style of governance. Bowman is a Kansan and a long-time aide of Sen. Bob Dole. With Dole’s favor, she spent two years as that state’s commissioner of banking.
Waller, a Bemidji State econ grad, spent 10 years as research director, the No. 2 policy position, at the St. Louis Fed. He was generally in favor of low interest rates. However, in 2021, during COVID and already a governor, he did call for higher rates as inflation took off.
Michael Barr, who last week rose to refute his colleagues, is a policy wunderkind with a law degree from Yale. Like President Bill Clinton he is a Rhodes Scholar. He clerked for Supreme Court Justice David Souter. By age 30, he was a special assistant to Clinton’s Treasury Secretary Robert Rubin. He moved to a policy position and returned to the Treasury in the Obama administration before coming to the Fed. So he is a heavy hitter.
Barr also was an architect of nearly every post-2007-09 financial debacle regulatory action — the Dodd-Frank Wall Street regulation act, the Consumer Financial Protection Bureau, limitations on credit card and “industrial loan” abuses. He also fought to implement the “Volcker Rule,” limiting speculative investments by “depository institutions” — banks — that the industry fought tooth and nail. All these regulations are now targets of the Trump administration and the GOP in Congress.
With Barr publicly opposing his renegade colleagues, the leadup to the next FOMC meeting, July 30- 31, seems like a standoff from Gunsmoke. A rough gang wants to go tarryhooting all around Dodge. Marshall Powell quietly steps into the street and says he won’t allow it. Citizens Bowman and Waller step into the street to join the yahoos. But Barr, a respected town leader, joins Powell. And five district bank presidents from New York, San Francisco, Chicago, Boston and Richmond, four of whom will vote, also step onto the street saying, “At least not today boys!”
While not that cinematic, and no one will be shot, the next FOMC meeting likely will be a standoff. Each side may politely criticize each other. But the renegade gang will turn and ride out of town, at least for now, hoping others will join them six weeks later. That — a seemingly inevitable decision to lower rates — will depend on second-quarter GDP numbers, along with those from monthly price indexes and labor market indicators between now and then. Indeed, Powell said as much in his testimony before Congress.
Unfortunately, nearly everyone, at least in the media and general population, let alone Congress and the White House, will ignore the most important indicator — the money supply. Remember the Fed does not control interest rates, it only influences them. Yes, the FOMC does set a target for one very short-term interest rate — overnight loans between banks or “fed funds.” But fears of inflation or economic disruptions can drive longer-term rates — as for home mortgages, business loans and farm operating money — higher even if the Fed lowers its target rate. It would be nice if Trump understood this instead of reflexively scapegoating Powell.
Starting in March 2020, at the first FOMC meeting after the first U.S. COVID case was diagnosed, the Fed boosted the M2 money supply to an unprecedented degree. It was up 25% by the time Joe Biden was inaugurated 10 months later. The cumulative rise topped out at 40.6% in April 2022, more than over the entire high-inflation years of the Carter administration.
The term “inflation” here is a two-part metaphor for what happened next. The money supply ballooned so did consumer prices. And that doomed the Biden presidency from the beginning. The Fed had held “interest rates” — at least the short-term one it controls — steady at 0.25%. Few looked at the money expansion needed to achieve that.
However, in March 2022, the Fed started to tighten, raising the Fed funds target to 5.5% by mid-2023 by slowly bleeding the money supply back down so that by November of that year, M2 was only 34% higher than pre-COVID. But then market forces grabbed the wheel. To keep short-term rates from being driven above its target, the Fed had to goose the money supply again, month by month. This has been especially true since it started cutting the target rate nine months ago.
The upshot is that by last month, the money supply was 42% greater than it was pre-COVID while real output is not even 14% greater. That is like a dud WWII bomb of money. It could explode if someone shakes it too much. But few realize it is there, again waiting to goose inflation, tariff effect notwithstanding.
And all this doesn’t even get at the other issues the Fed chair has had to deal with in the past week.
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St. Paul economist and writer Edward Lotterman can be reached at stpaul@edlotterman.com.
