Updated at 11:55 a.m. Wednesday:
Correction: An earlier version of this blog post said there were two Fed board nominees still awaiting confirmation. There are three awaiting confirmation. This post has been updated.
“I’m not thrilled with his raising of interest rates, no. I’m not thrilled,” Trump told Reuters on Monday, referring to his choice for Fed chairman, Jerome H. Powell.
This follows other occasions over the past several months in which Trump and others in the White House have tried to jawbone the Fed into keeping interest rates low, even as the economy improves and inflation picks up (i.e., the conditions under which central banks would reasonably raise rates). While there has been lots of scolding in the financial press about these comments, threats to the Fed’s independence have mostly been crowded out by other, sexier topics.
So allow me to explain why this is a Very Big Deal and One You Should Care About.
Since the beginning of time, politicians have always had an incentive to reduce interest rates and print more money. This gooses the economy in the short run, reducing unemployment and squeezing out a little more growth. Such effects are, as you might expect, especially desirable in an election year.
But the trade-off is that easy money, especially when the economy is doing well, leads to inflation. And that inflation can be caused not just by politicians printing money and cutting rates today, but by the belief that they might do so in the future. People start jacking up prices and wages in anticipation of more money being pumped into the economy.
So, generally, we want to shield monetary-policy decisions from the temptations of day-to-day politics. Even politicians generally agree in principle that their hands should be tied. After all, plenty of economic basket cases abroad — Venezuela, Argentina, Italy pre-euro — provide vivid examples of what can happen when politicians have control of the printing press.
In the United States, we handle this by outsourcing monetary policy to the Fed. The Fed, the most powerful central bank in the world, has a “dual mandate” of maximum employment and stable prices — that is, the two objectives that, as mentioned earlier, face trade-offs against one another.
The Fed is independent, for which it has a long-cultivated, hard-won reputation. While the central bank has been far from perfect, this independence has been critical for the bank’s credibility and by extension the long-term health of our economy.
It allows the Fed to make decisions that are unpopular in the short term — the proverbial “taking the punch bowl away” — to prevent the economy from overheating and to tamp down inflation. One famous example is when Paul Volcker sharply raised interest rates to tame out-of-control inflation in the 1980s.
The Fed has not always been free of political arm-twisting; the high inflation we experienced in the 1970s has been in part blamed on political pressure for easy money placed on Fed chairmen by the Johnson and Nixon administrations. The last time a sitting president openly attacked Fed policy was George H.W. Bush, in 1992.
But since 1993, under Bill Clinton, administrations have had (rarely broken) policies of refraining from commenting on Fed policy. Period. The risks of compromising the Fed’s credibility were just too great.
We’re in one of the longest recoveries on record. Unemployment is very low, and inflation is finally picking up a bit. Economists may disagree about the right pace of rate hikes, but it’s hardly unreasonable for the Fed to decide that, after more than a decade of historically low interest rates, it’s time to start normalizing them (which it has been doing, slowly, for the past few years).
Trump, however, is a fan of easy money, seemingly regardless of the state of the economy. “I do like low interest rates,” he told the Wall Street Journal last year.
He also does not have much respect for tradition of Fed independence. This is evident not only from his public temper tantrums about the Fed but also from what he apparently said to potential Fed nominees during private interviews. Kevin Warsh, a former Fed governor who was on Trump’s short list to become chair, told Politico in May:
“If you think it was a subject upon which he delicately danced around, then you’d be mistaken. It was certainly top of mind to the president,” Warsh said about Trump’s questioning on interest-rate policy. “The president has a view about asset prices and stock markets. He has a view based on his long history in his prior life as a developer and real estate mogul of the role of interest rates.”
Warsh added that he did not have the impression that Trump viewed the central bank as an independent organization meant to make decisions in the best long-term interests of the economy rather than at the bidding of the White House or any other political institution. “In some sense the broader notion of an independent agency, that’s probably not an obvious feature to the president,” he said.
One irony, of course, is that by choosing not to renominate former Fed chair Janet Yellen in the first place, Trump virtually guaranteed himself a Fed more concerned with creeping inflation, and more inclined to raise interest rates. Yellen is widely seen as a dovish (less worried about inflation) central banker; by contrast Powell, like Republicans more generally, is more hawkish.
So far, markets don’t seem to be super worried about Trump’s inappropriate comments attacking the Fed, and that may be precisely because the hawkish Powell is unlikely to bend to Trump’s will. Trump can’t remove the Fed chair, who has nearly four years left before he’d face renomination besides. Some economists have even suggested to me that Trump’s comments urging lower rates may instead backfire. To prove to markets that the bank is free of White House influence, Powell might feel he has no choice but to raise rates faster than he might otherwise.
However, that doesn’t mean we should stop worrying about Trump’s threats to one of the country’s greatest macroeconomic policymaking assets: the credible independence of our central bank.
There are still a lot of vacancies on the Federal Reserve Board of Governors that Trump gets to fill, after all. Out of seven slots total, four are currently empty. (Three nominees are awaiting Senate confirmation; one of them, Marvin Goodfriend, may still not have enough Republican votes to get confirmed, leaving his chances in some doubt.) Based on his apparent buyer’s remorse about Powell, Trump may well decide that he want other picks to be both more dovish, and more pliant, than those he’s chosen already.