U.S. Treasury Secretary Janet Yellen (L) and Federal Reserve Board Chairman Jerome Powell (R) testify during a hearing before Senate Banking, Housing and Urban Affairs Committee on Capitol Hill November 30, 2021 in Washington, DC.
Alex Wong | Getty Images
When President Joe Biden nominated former Fed Chair Janet Yellen to run the Treasury Department, his rationale was simple: “No one is better prepared to deal with this crisis.”
The crisis to which he referred was a “K-shaped” economic recovery that had exacerbated inequality in the wake of a once-in-a-generation pandemic. The administration had a simple plan, and Yellen would help carry it out. Once hundreds of millions of Americans were vaccinated against Covid-19, and trillions of dollars in new government spending flowed into the economy, the world would return to normal under a supercharged recovery.
One year later, a different problem — inflation — is dampening the recovery, sucking the oxygen out of strategy sessions, angering voters and threatening Democrats’ razor-thin governing margins. This is happening despite warnings from economists and months of vows from the Federal Reserve and the White House it would be short-lived.
Yellen, having herself helmed the central bank, which is tasked with monitoring and managing inflation, would seem uniquely suited for a moment when inflation is hitting four-decade highs. So how did the Biden administration miss the warning signs, and end up in this position?
More than a dozen economists, current and former administration officials, and former Fed officials — requesting anonymity to speak candidly about private discussions — point to a confluence of issues, including heavy Fed influence across the administration, overreliance on traditional forecasting, the political pressure to spend big, and a lack of urgency in deciding who would run the Federal Reserve and carry out its mission of managing inflation.
“It’s always going to be an issue in any White House, how the policy and politics interact,” said a former Fed official, who requested anonymity to discuss private discussions with the administration. “I just think they miscalculated.”
The Fed and the White House declined to comment on the record.
The think tank Treasury
When Yellen took office in early 2021, she moved quickly to staff up Treasury, which was understaffed after the departure of Trump administration political appointees and because her predecessor, Steven Mnuchin, had shrunk the department. To do so, Yellen poached experts in economics and labyrinthine political processes from the well she knew best — the Federal Reserve — causing a revolving door of new hires to spin even more quickly than normal.
Among those who came from the top ranks of the Fed to advise Yellen directly at Treasury: Linda Robertson, Michael Kiley and former Fed attorney Mary Watkins. Robertson and Kiley served on limited-term details and have since returned to the Fed, Robertson to shepherd the nominations of top Federal Reserve officials, and Kiley in a senior role overseeing financial stability. Watkins remains at Treasury as an attorney-advisor working on digital currencies.
A familiar joke began circling the halls of the Federal Reserve, comparing the Yellen Treasury to the administration of Italian Prime Minister Mario Draghi, who had been filling out his ranks with colleagues from his days working at the European Central Bank and the Bank of Italy.
“It was like, ‘The problem in the modern world is trying to ensure that administrations are independent of their central bank, not that the central bank is independent from the administration,” according to a second former Fed official who requested anonymity to discuss private discussions.
The Fed influx continued, reaching Treasury’s organizational masthead, White House policy positions and other regulatory agencies.
The two deputy directors of the White House’s National Economic Council — Daleep Singh and Sameera Fazili — have Fed and Treasury ties. The Council of Economic Advisers, which Yellen once chaired, features former Fed economists. And atop the Office of the Comptroller of the Currency, a banking regulator, sit two former Federal Reserve regulatory and legal officials whom Yellen recommended.
Fed alums feature prominently in Treasury’s top personnel appointments. Nellie Liang, undersecretary for Domestic Finance, was previously the Fed’s founding director of financial stability. Acting general counsel Laurie Schaffer was previously the Fed’s deputy general counsel. And at least three deputy assistant secretaries with jurisdiction over financial regulation and macroeconomics hail from the Federal Reserve system.
The result, according to several officials who requested anonymity because they were not authorized to speak publicly, is an agency that’s been described as operating like a “think tank,” in a “Fed-like posture,” and taking an “unusually analytic” approach to a traditionally fast-moving agency focused on implementing a firehose of policies and problem-solving measures to promote the president’s agenda. They tended to dwell on similar data as the Fed, a detail that became problematic as the pandemic rendered those models irrelevant.
While the volume of former Fed personnel within the Treasury has increased communication between the administration and the central bank, the more formal channels are also well established.
Monthly lunches with the Council of Economic Advisers — the White House’s in-house forecasting shop — have largely resumed after a pause due to the pandemic and frequent personnel changes toward the end of the Trump administration. Fed Chairman Jerome Powell and Yellen trade views over a weekly breakfast, a tradition Yellen carried out when she chaired the central bank.
Kevin Hassett, who broke bread with both Yellen and Powell when he chaired Trump’s Council of Economic Advisors, said Yellen would be better served by staff with a more balanced approach, but that the close bond between Treasury and Fed remains important.
“They come at things from different angles,” Hassett told CNBC. “But I think they’re a good team.”
Sarah Binder, an historian and senior fellow at Brookings Governance, notes that close coordination on monetary and fiscal policy is necessary in times of crisis but comes with an asterisk.
“Certainly, trust is important,” says Binder, who researches Federal Reserve independence. “The only thing one might ask here is whether there is a danger of groupthink if that’s the only set of voices.”
Supply vs. demand
Hassett was part of a trio of former White House economists, including Clinton Treasury Secretary Larry Summers and Obama CEA chair Jason Furman, who warned early in Biden’s term that inflation was afoot, when the government was more concerned with Covid. They parsed different data but arrived at the same conclusions: Trillions in stimulus spending being plowed back into the economy when companies couldn’t produce enough of what consumers wanted would drive prices higher.
“It’s obvious to a person who does macroeconomic modeling of the modern variety that inflation was going to take off,” Hassett told CNBC. Last April, Hassett declared that the inflation “fire was on” and by June determined that inflation would reach 7% by the end of the year.
Indeed, the consumer price index report for December showed that inflation grew at an annual rate of 7%, the hottest pace since 1982. Prices for core personal consumption expenditures, the Fed’s preferred inflation gauge, rose 4.9% in December compared to the prior year and rose 5.8% including gas and groceries.
At the beginning of 2021, traditional forecasts were far more muted: The private sector estimated 1.8% by year-end, the same as the Federal Reserve, and the Congressional Budget Office was tracking even lower at 1.5%. The White House’s own estimates — calculated by the “troika” of the Council of Economic Advisers, Treasury and the Office of Management and Budget — hewed closely to those figures.
“We ultimately sort of came within spitting distance of where the Fed was, but we came there by our own independent analysis,” a Treasury official told CNBC.
On virtual discussions in early spring, White House officials acknowledged the possibility of inflation wrought by stimulus and infrastructure spending, but the risk was dismissed by officials citing the political popularity of the policies and the desire to add more fuel to the economic recovery, according to three people involved in or briefed on discussions.
In calling for passage of the $1.9 trillion pandemic stimulus bill, just a month after Congress approved a separate $900 billion package, Biden often lamented the small size of the $800 billion stimulus passed in 2009 during the financial crisis and the weak economic growth that followed.
“We have learned from past crises: The risk is not doing too much. The risk is not doing enough,” Biden told reporters from the Oval Office in late January. He signed the bill into law in March.
Yellen voiced support for the administration’s desire to “go big,” but was also circumspect on the possibility prices might rise. In a series of Sunday TV news appearances, she said inflation was a “risk” of stimulus, and in May, she went a step further — suggesting interest rates may need to rise to keep a lid on inflationary pressures, a comment she later walked back.
“Janet [Yellen] was concerned about inflation for a long time,” Furman, the former Obama economist, told CNBC, differentiating the Treasury secretary’s approach from that of the White House. “There was a lot of wishful thinking that, like, everything increasing inflation would go away, but nothing new would emerge to cause inflation.”
A Treasury spokesperson said Yellen believes the legislation backed by the president was sound economic policy that engendered a faster recovery than expected with less financial pain.
“Secretary Yellen would be the first to say there is more to be done and Treasury continues to work each day to foster a strong and equitable recovery,” the spokesperson added.
By the summer months, discussion — and acknowledgment — of inflation ramped up across the administration, according to multiple current and former officials. Internal estimates began to rise in reflection of that, they said. Private sector estimates rose to 3.7%, while the Congressional Budget Office and the Federal Reserve saw inflation closer to 3% by the end of the year.
Treasury was coming around to the idea that prices would be going — and perhaps staying — higher than they had forecasted, the official said. For his part, Fed Chairman Powell mentioned in a July 14 congressional hearing that inflation was rising in “a number of categories of goods and services.”
The CEA was beginning to question the underlying thesis, too. A former Fed official recalls White House economist Heather Boushey raising the question about the cause of inflation during one of the monthly lunches during the summer, to wit, if the issue was one of supply — factory closures and transportation logjams and worker shortages limiting the goods that could get to consumers — that would work itself out.
But if the issue was demand — confident consumers with money burning a hole in their pocket — that could only be kept in check by the Federal Reserve.
Publicly, the administration was still voicing hope the trend would be short-lived.
“Our experts believe and our data shows that most of the price increases we’ve seen were expected and expected to be temporary,” Biden said in July. By August, Yellen’s definition of “temporary” indicated the price increases would subside by the end of the year.
The autumn pivot
By fall, as persistent inflation began to erode Biden’s approval rating, the administration shifted its message. Cabinet officials pounded the pavement, pointing to inflation as a sign the economy had strengthened, effectively implying the Fed might need to act.
“Part of what’s happening is not only on the supply side, it’s the demand side,” said Transportation Secretary Pete Buttigieg on CNN on Oct. 18. “Demand is off the charts.”
A week later, Yellen, ever aware of choosing careful language on a market-moving issue, laid out a significantly longer timeline for inflation pressures to ease, signaling they wouldn’t do so on their own.
“The inflation rate will remain high into next year because of what’s already happened,” Yellen told CNN on Oct. 24. “But I expect improvement by the end of … by the middle to end of next year, second half of next year.”
While the White House was discussing short-term fixes to the supply chain and gas prices, tackling longer-term inflation falls to the Federal Reserve. But Biden had yet to decide whether he would keep Powell on to lead the Fed after his term expired in early 2022, putting the central bank in an awkward position of confronting a vexing monetary-policy decision without the clarity of who would be carrying it out. Yellen had advocated for a second Powell term, but progressive lawmakers behind the scenes were seeking assurances the Fed board would be refashioned with more liberal economists who would reflect their priorities.
U.S. President Joe Biden announces the nomination of Federal Reserve Chair Jerome Powell for a second four-year term, in the Eisenhower Executive Office Building’s South Court Auditorium at the White House in Washington, U.S., November 22, 2021.
Kevin Lamarque | Reuters
Then, on Nov. 8, Randal Quarles, a Fed governor appointed in 2017 by Trump, announced he would resign from the board 11 years before the end of his term, creating a vacancy that allowed Democrats to make up the majority of the seven-member board.
The Quarles resignation served as something of a fulcrum for the shift that followed, though the extent to which is unclear. A person involved in the discussions told CNBC the new vacancy was a factor in the timing of Biden’s decision to renominate Powell as chairman. A second person briefed on the matter suggested the resignation was simply a “convenient rationale” for a decision that had simply been delayed. The White House disputed any link between Biden’s decision and Quarles’ resignation.
By the time Biden nominated Powell to a second term and Lael Brainard as a vice chair in late November, #Bidenflation was trending on Twitter, and “transitory” — the Fed’s long-favored descriptor for the inflation trend — was being made into memes. Biden, Powell and Brainard all pledged publicly to tame inflation at the nomination ceremony.
In hindsight, current and former administration officials and the two former Fed officials said the administration’s best weapon in combating inflation would have been an earlier nomination that empowered the Fed to move sooner.
But Powell denies that personnel moves delayed the Fed’s pivot toward raising interest rates, which was announced a week after his nomination. He said in a press conference that he and his colleagues set to work on the strategy after parsing the early November data on jobs and inflation, after which several Fed officials publicly called for faster action.
“That doesn’t happen by accident,” Powell told reporters on Dec. 15. “They were out talking about taper before the president made his decision,” referring to the Fed’s move to scale back its bond-purchase program.
As Powell awaits confirmation, the White House remains optimistic inflation will ease through a combination of the Fed’s now-telegraphed interest rate hikes and an eventual return to normal as the pandemic subsides.
White House chief of staff Ron Klain told CNBC that Biden is not considering any personnel changes in the West Wing or Treasury stemming from inflation.
The same models that underestimated inflation in 2021 now call for moderation by the end of 2022, right as midterm voters will have their say at the ballot box.
Furman, the Obama administration veteran, said he fears inflation will get worse. But he also said the White House is wielding a better tool: realism.
“One tool they were not using before but they have been for the last couple months is not overpromising,” Furman said. “There had been this claim that the inflation was about to go away. Now, they’re being much more realistic.”
– CNBC’s Steve Liesman and Patrick Manning contributed reporting