Steven Rattner makes several valid points, or at least points with which I agree, in this defense of the Federal Reserve from critics on the right and the left. It is true that the Federal Reserve’s reputation for independence serves a useful purpose for the economy — as the markets seemed to underscore a few months ago, when they dropped sharply in response to reports that President Trump wanted to fire Fed chairman Jay Powell. I agree, as well, that the case that the Fed’s interest-rate hike in December was a disastrous mistake is a weak one.
But I think Rattner’s perspective is off in several respects. I’ll quote him and add commentary.
Mr. Trump and his aides base their call for the Fed to lower rates on quiescent inflation, a phenomenon that could well be either aberrational or a new normal. Put me down as generally skeptical of pronouncements of a new normal.
And having come of age as a young Times reporter covering economic policy during a period of rampant inflation, I’m particularly skeptical of declaring inflation dead and buried.
So low inflation is “aberrational,” Rattner concludes. Here are a few reasons for thinking otherwise. First, inflation has generally been in decline for several decades, the last period of high inflation having taken place from roughly 1966 through 1981. Second, inflation has been below the Fed’s own target rate for most of the last decade. Third, neither policymakers nor economists, generally speaking, believe that under normal circumstances it makes sense to attempt to boost economic growth and employment by running a looser monetary policy; many economists and policymakers believed it was a reasonable strategy during Rattner’s young adulthood. Fourth, we have better tools for forecasting future inflation than we did back then, making it less likely that galloping inflation will surprise us. Market expectations of inflation continue to register low.
Regardless, few mainstream economists believe that the interest rate increases to date have impeded the recovery, nor would cutting them materially accelerate growth. . . .
I will assume that he means for “materially” to modify both halves of that sentence. But presumably those economists don’t believe that cutting rates would “materially” increase inflation either. If the effects of small interest-rate changes would also be small, that modest magnitude ought to enter both sides of the evaluation. Rattner is using it in a one-sided way.
Remarkably, [progressives] argue that the Fed was insufficiently aggressive in fighting the 2008 downturn.
Too timid? Really? In unprecedented actions, the Fed kept interest rates close to zero for seven years and engaged in an aggressive bond buying program known as quantitative easing.
Earlier, Rattner called the Fed’s critics “about as wrong as imaginable.” His imagination seems straitened. Low interest rates are not necessarily a sign of monetary laxity, as we should have learned from the Great Depression. Nor is a large (or growing) central-bank balance sheet: Look at Australia, which has had a higher inflation rate and nominal-spending growth rate with a smaller one.
Rattner wholly ignores the Fed’s equally unprecedented action of paying interest to banks on their excess reserves, a policy that undercut the Fed’s expansionary moves. It is certainly true that the Fed could have run a tighter policy, as the European Central Bank spent much of the last decade doing, but it should not be considered strange to argue that it could and should have more forceful. (It could, for example, have refrained from raising interest rates over the last four years given that inflation has been below target.)
What progressives don’t understand is that while it is immensely powerful, the Fed can’t solve all our economic problems. For example, weak productivity growth and raging income inequality need to be addressed through legislative action: better tax policy, increased spending on infrastructure and the like.
Maybe progressives don’t understand that — although they don’t seem to lack advocates of egalitarian tax-policy changes and added infrastructure spending — but Rattner here seems to be confusing two different propositions. One can believe that the Fed should have run a stronger anti-recession policy without believing that the Fed can do everything.
Rattner’s argument is unbalanced in another way. While political attacks on central banks can certainly go too far, concern for its independence can also become a justification for complacent and reflexive defense. That’s exactly what it seems to have done here.