Magazine | January 28, 2019, Issue

Money Trouble

(Roman Genn)
Trump vs. the Fed

Divining why stocks have moved up or down is a perilous business. Even if an analyst gets the explanation right, he should remember the artifice in attributing a point of view to “the market” — as though there are things it thinks, wants, and fears. But stocks did sink in December when the Fed raised interest rates and signaled more rate increases were coming the next year, and they sank again on reports that Trump is so unhappy with this course that he is considering trying to fire Fed chairman Jay Powell. Treasury Secretary Steve Mnuchin then said that the president had told him that he does not believe he has the legal authority to fire Powell.

Trumpologists have offered several explanations for the president’s repeated and sometimes heated criticism of the Fed (the words “crazy” and “loco” have featured). It reflects a real-estate developer’s natural bias against high interest rates, goes one theory; or it is an attempt by Trump to set up the Fed to take the blame should the economy go south. More likely, it reflects the natural bias of nearly any president considering running for reelection. At key moments, LBJ, Nixon, Reagan, and George H. W. Bush all wanted a looser monetary policy than the Fed was giving them.

Whatever Trump’s motive, he may be right, as even some liberal economic commentators are saying. After rising, inflation has started coming back down, which can be a sign of economic weakness. Market expectations of inflation, as measured by the difference in yields between Treasury bonds that are indexed for inflation and those that are not, have been falling too. We have been moving closer to an inverted yield curve, with long-term interest rates lower than short-term interest rates, which is generally considered a sign of impending recession.

Then there’s the stock market’s behavior, which suggests at least a risk that an excessively tight monetary policy will reduce future corporate earnings. From 2008 onward, but not before then, market expectations of inflation have been correlated with stock prices: They have risen and fallen together. A possible inference: Markets don’t always “want” looser monetary policy — don’t always, that is, incorporate the judgment that looser policy would strengthen the economy — but have wanted it in the conditions of the last ten years.

Telling against Trump’s concern about the Fed, on the other hand, is that employment, output, and wages have all been rising nicely. These are “backward-looking” indicators: They tell us about how the economy has been performing, not how it will perform, and the forward-looking indicators, such as stocks, are worse. The forward-looking indicators are, of course, less reliable; but one reason they are less reliable is that they sometimes prompt corrective action that prevents the fears they register from coming true. Which leaves the debate unsettled.

Until Trump began to criticize the Fed, the prevailing view among conservatives involved in monetary-policy debates had been that the Fed has been keeping interest rates too low and otherwise running a dangerously loose policy — one that risked causing runaway inflation and asset-price bubbles. Many conservatives have recently abandoned this perspective, however, and joined Trump in warning against further rate hikes.

On its face, it is a curious shift. Nearly any theory of monetary policy suggests that the time to loosen is when inflation is low and unemployment is high, and the time to tighten is when inflation is high and unemployment is low. Debate typically concerns when inflation or unemployment is too high, what to do if both are high at the same time, and so forth. Yet some of the same conservatives who urged tighter money from 2009 to 2014, when unemployment was higher and in­flation lower than now, want a looser policy today. The perverse implication is that the Fed should be making the ups and downs of the business cycle more severe rather than trying to smooth them out.

One proffered justification for the change is that Trump’s economic policies have supercharged the economy: If the economy has greater potential for non-inflationary growth, then the Fed should be less worried that the economy is running too hot. It’s an argument that simultaneously goes too far and not far enough. The Fed should not be setting a speed limit for real economic growth. But if potential growth has risen, that’s a reason for interest rates to rise too. The Trump administration’s view is that the economy is doing better than ever but cannot survive interest rates in line with historical averages. The combination makes no sense.

Neither does President Trump’s suggestion that the Fed should hold off on raising interest rates as a way of aiding his trade wars. Trump’s remark concedes that the trade war is having a negative effect on the economy, which is progress of a sort; but it is not a negative effect that the Fed can counteract. Steel tariffs hurt companies that use steel, for example, by raising the price of their inputs relative to the price of their output. The Fed can’t change that.

Trump’s understanding of monetary policy is hazy, something that does not distinguish him from most politicians. It is not, then, surprising that markets would register a preference for central bankers to do their job without political interference, even in cases where they happen to be more in sync with the president than the bankers on the question of the moment. The norm of presidential silence about Fed policy is a recently developed one. It did not reach its current strength until the 1990s. Since monetary policy is one of the most consequential things governments do, there is no strong principled case that presidents should not comment on it.

Adhering to the norm, however, re­duces the risk that political pressure will induce serious monetary errors, and therefore strengthens confidence that monetary policy will be relatively sound. The Fed knows that its reputation for independence is economically valuable, and it has an institutional interest in guarding it. So when Trump campaigns against rate hikes, the Fed has reasons to avoid appearing to succumb to the pressure. To the extent Trump wants the Fed to hold off on rate hikes, his public commentary is self-defeating.

If he wants to be able to blame the Fed for a downturn, on the other hand, the commentary is probably futile. Presi­dents get the credit for good economic times and take the blame for bad, whether or not they deserve either. And since Trump’s Fed is dominated by his own appointees — he made Powell the chairman — a disastrous performance by the central bank would reflect poorly on him anyway.

This is doubtless a frustrating situation for the president, so expect more market volatility.

Ramesh Ponnuru is a senior editor for National Review, a columnist for Bloomberg Opinion, a visiting fellow at the American Enterprise Institute, and a senior fellow at the National Review Institute.

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