Steady Monetary Policy is Expected From the Federal Reserve Chair Nominee Jerome Powell

On November 2nd, Jerome H. Powell was nominated to be the new chair of the Federal Reserve. Powell's influence on monetary policy will be of direct interest to investors and producers in the cannabis industry who desire accurate expectations for future interest rates. The New York Times’ profile of Powell notes that “he would be the first Fed chief in more than four decades who did not have an economics degree.” Jerome Powell earned a law degree from Georgetown University and began his career as a lawyer. Powell then worked in investment banking and became a multimillionaire as a partner of the Carlyle Group, an asset management firm. After leaving the Carlyle Group, Powell worked for the Bipartisan Policy Center and lobbied congressional Republicans to raise the debt ceiling, drawing attention from the Obama administration. Soon after, Powell was nominated by President Obama to serve on the Federal Reserve's Board of Governors. Powell has now been nominated to chair the Board of Governors and will be the predominant influencer of monetary policy in the United States.

Monetary policy is set by the Federal Reserve board with aims to influence the amount and growth of money supply and economic production. Both the money supply and economic production affect inflation and interest rates, both key factors to investors and producers in the cannabis industry. Therefore, a better understanding of possible trajectories of the Federal Reserve's monetary policy under Powell can help cannabis businesses and investors plan for the future.

Speaking at his nomination announcement, Powell relayed his commitment to steady rates of inflation and full production:

“ If I am confirmed by the senate, I will do everything within my power to achieve our congressionally assigned goals of stable prices and maximum employment. ”

Powell continued by commenting on the health of the economy:

“ In the years since the financial crisis ended, our economy has made substantial progress toward full recovery. By many measure, we're close to full employment and inflation has moved up toward our target. Our financial system is also, without doubt, far stronger and more resilient than it was before the crisis. Our banks have much higher capital and liquidity. They're more aware of the risks that they run and they're better at managing those risks. ”

Powell's strong belief in a rebound of the economy suggests that he will be inclined to raise the federal funds rate if economic measures continue to look favorable and inflation trends towards the Federal Reserve's objective.

Powell's view on the economy

Powell has suggested that labor market indicators show that the economy has improved significantly since the 2008 financial crises: the unemployment rate has drastically fallen, experts believe the economy is near full employment, average hourly earnings are rising. However, Powell does admit that growth in consumer spending has been low and business investment has fallen. At the 2015 Annual Community Bankers Conference, Powell remarked:

“ The Federal Reserve recognizes the importance of a healthy community banking sector for our nation's prosperity, and we are committed to understanding the challenges faced by community banks and to carefully considering the effects of new regulations on these institutions. ”

Powell continued commenting on the challenges that community banks face:

“ I firmly believe that community banks are here to stay. Banks of different sizes serve different functions, and both large and small banks are needed to meet the funding needs of a healthy economy. ”

Powell's remarks suggest that the Federal Reserve will be committed to protecting community banks in the coming years. Community banks are vital to cannabis businesses, because large financial institutions largely shun the cannabis industry. Until the cannabis industry becomes federally legal, large banks will likely not provide loans and services to businesses who serve the cannabis industry. Therefore, Powell's pledge to protect community banks is beneficial to cannabis businesses who rely on community banks for financing.

Powell's concern for liquidity

Market liquidity is the ability to buy or sell an asset in the market without significant markup or discount. Liquidity is a major factor to cannabis businesses, who may find it difficult to purchase from timid vendors as well as to sell used equipment.

In a statement, Powell hypothesized, “even if liquidity is adequate in normal conditions, it has become more fragile, or prone to disappearing under stress.” Powell's conjecture may explain liquidity problems in the emerging cannabis industry, which is under immense stress from opaque and ever-changing regulations. At the Brookings Institution's Initiative on Business and Public Policy, Powell questioned if “rapidly diminishing liquidity and large price moves for a given quantum of news” is the new normal. From his speech, it is clear that Powell believes liquidity is currently a major problem in financial markets. Investors and producers in the cannabis industry likely share Powell's interest in policies that increase financial liquidity.

Powell further questioned, “I would start by asking are there important market failures that are not likely to self-correct. And if so what are the causes and what are the costs and benefits of market led or regulatory responses?” Powell's remark marks it clear that he believes in a measured government response to potential market failures. Powell concludes by stating his expectations that market participants and regulators will find changes in trading and risk management practices and regulation in market structure that could make financial markets more liquid and resilient.

Powell's plan for interest rates

The Federal Reserve's monetary policy directly affects benchmark interest rates, which has a rippling effect across financial markets. Investors, producers and consumers in the cannabis industry will all be effected by changes in the cost of borrowing. Investors see the cost of borrowing as their price to lending. Therefore, investors are generally pleased with higher interest rates. The rate of return in the cannabis industry is high, so, it is more likely that risk is the main factor that is keeping investors from supplying finance to the cannabis industry rather than the nominal rate of return. However, if interest rates are raised, then it is expected that there will be a greater supply of finance available for producers in the cannabis industry.

Many cannabis producers already face high borrowing costs because there are limited financial suppliers willing to exchange with cannabis businesses. The low supply of willing investors results in minimal competition between cannabis industry financiers and therefore high interest rates. The Federal Reserve's plan to raise interest rates will only increase the already exorbitant cost of borrowing that cannabis businesses face. However, cannabis businesses can hope that a greater supply of investors may help to increase competition and lower rates.

Interest rates are still historically low from the Federal Reserve's unprecedented rate cut to near zero following the 2008 financial crises. The Federal Reserve lowered interest rates to encourage borrowing in hopes of strengthening the economy. By many measures, the economy is regaining its health and the Federal Reserve has begun to gradually raise interest rates. Higher interest rates encourage investment, but discourage financial borrowing by producers, which tends to reduce economic output. Inflation is positively related to economic output, so, if there is a reduction in economic activity, then inflation will also fall. Following the 2008 financial crises, the economy experienced deflation and alarmingly low rates of inflation during the recovery. The primary goal for the Federal Reserve is to now raise interest rates towards their pre-crises level, while monitoring for falling inflation rates, so that monetary policy can help to alleviate the effects of the next recession.

Powell is inclined to believe that labor force productivity has decreased, leading to low capital investment that in turn has reduced the U.S. economy's long-run potential growth. With respect to monetary policy, Powell has said:

“ Lower potential output growth would mean that interest rates will remain below their pre-crisis levels even after the output gap is fully closed and inflation returns to 2 percent. ”

Therefore, unless there is strong growth in the U.S. economy, interest rates are expected to remain historically low for the foreseeable future. Powell has suggested that, while monetary policy can be a limited aid, policies from other branches of the government are needed to booster economic growth:

“ We need policies that support labor force participation and the development of skills, business hiring and investment, and productivity growth--policies that are, for the most part, outside the remit of the Federal Reserve. Monetary policy can contribute by continuing to support the expansion as long as inflation remains consistent with our 2 percent objective. ”

The New York Times has reported that Jerome Powell is “expected to stay the course on monetary policy if the economy continues its steady growth.” Powell is expected to continue to gradually raise interest rates. If Powell continues monetary policy in line with Chair Janet Yellen's history, then it is likely that there will be 3 small interest rate hikes in the coming year if the economy's good health continues.

Powell's objective for inflation

Prolonged low rates of inflation decreases the likelihood that the Federal Reserve will raise interest rates, however, if the U.S. economy continues to produce healthy metrics, then the Federal Reserve is expected to continue its slow and gradual increase of the benchmark interest rate.

When commenting on his outlook for the economy and monetary policy, Powell noted that inflation has been concerningly below the Federal Reserve's target:

“ Most [Federal Open Market Committee] FOMC participants anticipate that inflation will gradually move up to the FOMC's 2 percent target over coming years. Continued low or falling inflation could, however, raise real concerns. Inflation can be too low as well as too high. I have no doubt that the Committee will monitor this carefully and defend the inflation goal ‘from below,’ if necessary. ”

Powell believes that it is essential for inflation to return to the Federal Reserve's 2 percent objective. Given his objective, interest rates will likely continue to be raised slowly under Powell, as the economy grows and inflation increases. Overall, the cannabis industry should benefit from the economic expansion.

Moving forward with Powell at the helm

Powell has suggested that a proposal “to require the Fed to adopt and follow a specific equation in setting monetary policy.” The well-known Taylor Rule, proposed by economist John B. Taylor, is a simple model that the Federal Reserve could use to set nominal interest rates in response to changes in economic output and inflation. The principle of the model is that good fiscal policy will let interest rates respond positively to inflation and fight inflation by changing interest rates more than the rate of change of inflation. The model argues that nominal interest rates should be increased as inflation increases in order to cool the economy, and interest rates should be lowered if inflation decreases in order to stimulate the economy. In addition to stability, the Taylor Rule would also greatly increase the transparency of the Federal Reserve's operations. Looking forward, the cannabis industry could greatly benefit from steady monetary policy and healthy financial institutions, and it will be of interest to many as to the direction of the Federal Reserve with Jerome H. Powell as chair.

Updated: Monday, November 20th 2017