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There is a common story that President Donald Trump attacked the independence of the US Federal Reserve on Twitter last week. This is wrong on several points.
First, the Trump attack was on the Fed itself rather than on its independence as such. He said he was "not happy" with upcoming interest rate increases and, at first, I too thought he was trying to prevent them. But after reflection, I decided that Trump is playing a more subtle game: laying the groundwork to accuse the Fed if something is wrong with the US economy.
Essentially, Trump wants a fall guy. He may secretly fear that his "trade war" and general political volatility – or just bad luck – are hurting the US economy. If this happens, Trump will need a political target to absorb criticism. With mid-term elections, he does not want to point fingers at Congress. Hillary Clinton can no longer serve as a plausible target. So, the Fed is the convenient scapegoat. The last thing he wants is that the Fed does exactly what he says because then he would have to blame only himself. He stressed, "I let them do what they think is the best."
If Trump really wanted lower interest rates, he could have named extreme doves to the Fed board. But in fact, he chose a mix of moderates and sometimes even (benign) inflation hawks. That's another sign that Trump is playing a blame game, rather than trying to undermine the independence of the Fed or to reach eternal low interest rates.
You could even claim that Trump tries to increase the independence of the Fed, but at the expense of its credibility. "Do not badociate these losers to me" is the message.
The other problem with interpreting Trump's tweets as weakening the Fed's independence is that the Fed has never been completely independent in the first place. For its part, the president appoints the governors of the Fed, subject to the approval of the Senate. On the other hand, Congress can revoke or amend the Fed's charter at any time.
Within these constraints, the Fed makes its own decisions. But it's not the same as saying that he's free to make the decision he wants. During a downturn, for example, the Fed could aim for 4% inflation, to stimulate aggregate demand. Its obvious reluctance to do so can be explained not by macroeconomic theory but by public opinion and, ultimately, by Congressional pressure. At a time of relative wage stagnation, higher inflation rates would lead to real wage cuts for many voters.
The result? Fed does not react enough to crises
To better see the role of politics here, compare the US Federal Reserve to the Reserve Bank of New Zealand, perhaps the least independent central bank of developed countries. Since 1990, New Zealand has put in place a system in which the Reserve Bank and the Minister of Finance agree on a range for the price inflation rate. In other words, the government badumes the basic responsibility for what the Reserve Bank will do. If the Reserve Bank fails in this regard, there is an obligation to explain what went wrong and why.
On paper, it is very different from the procedures of the US Federal Reserve. Yet, the Reserve Bank and the Finance Minister, acting in concert, chose inflation rates between 0 and 3%, with 2% as the desired midpoint.
In the United States, inflation rates were between 0 and 2% during the same period. And the United States and New Zealand have been somewhat below a 2% target recently. In other words, globally similar results end up being transmitted by very different institutional procedures.
That being said, Trump's Twitter explosion is likely to hurt monetary policy in the future. Ideally, the Fed would have more leeway to challenge public opinion and opt for higher inflation rates when the next economic crisis dictates it. Attacking the Fed will not help in this regard. What would, on the other hand, be a president – and a congress – who would indicate in advance that they will have the back of the Fed in an economic or financial situation.
Trump's tweets did not have a major impact on the market this time. The real danger is in the longer term, when the next crisis, when the concept of independence of the Fed means that the Fed is really alone.
This column does not necessarily reflect the opinion of the Editorial Board or Bloomberg LP
To contact the author of this anecdote:
Tyler Cowen to tcowen2 @ bloomberg .net
To contact the editor responsible for this story:
Michael Newman [19659019] at [email protected]
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