Trump's fight with the Fed and Jerome Powell, explained

President Donald Trump is "not even a little happy" with the Federal Reserve and the man he has called to head, President Jerome Powell. And he has no problem telling it.

Trump complains about the Fed for a while now, putting pressure on the interviews and on Twitter that the central bank complies with its will in terms of interest rates. At a meeting at the Washington Post this week, he continued his Fed offensive, calling this project a "much bigger problem than China" in the economy and expressing his anger at Powell, which he He chose as president of the Fed. In 2017, President Janet Yellen, whose term expired in February.

"I'm doing business and I'm not accommodated by the Fed," said Trump. "I'm not happy with the Fed. They make a mistake because I have an instinct, and my gut sometimes tells me more than anything the brain can ever tell me. "

The mistake he is talking about is the change in interest rates, one of the main jobs of the Federal Reserve. It is incumbent upon the Fed to influence the availability and cost of credit in the US economy by setting the "federal funds rate," which means that interest rate banks charge loans to the United States. day to day. Banks, in turn, increase the rates of interest that they charge to customers.

So, why does Trump care about what the Fed does with interest rates? In a nutshell, he worries that when he raises rates, it will hurt the stock market and slow down the economic growth promised by him.

William McChesney Martin, who led the Federal Reserve for nearly two decades, joked that the Fed's job is to "pull the bowl out of the punch just as the party goes away." To continue the metaphor, as if some bars were setting the clock a little fast to get everyone out before closing, the role of the Fed is to calm the economy just as the situation begins to unfold. # 39; s fun.

Trump wants his party to continue.

"It's really his expectations of what a Fed president is and the policy he sees as the most beneficial in the short term for him," says Sarah Binder, a professor of political science at the University of Toronto. George Washington University.

The Fed uses interest rates to influence the economy

When the Fed fears that the economy will overheat or inflation rise, it may raise interest rates to slow down the overall picture. This increases the cost of borrowing for banks and, consequently, for consumers, which ultimately affects spending across the economy.

The bank has a "dual mandate", a set of goals that it is expected to achieve: maximizing employment and stabilizing the prices of goods and services. In practice, this means that the Fed must try to keep the unemployment rate low – the idea being that if borrowing costs are low, companies will have more money to invest and get back to. develop to finally hire more workers – and aim for an inflation rate of 2%. because a higher inflation rate is more expensive than a lower rate.

During the Great Recession, the Fed cut interest rates to zero and held them for years to help the US economic recovery. The theory is that low interest rates stimulate both investment and consumption because it is cheaper to borrow, which is less incentive to save.

In December 2015, the Fed raised its rates for the first time since 2006, by 0.25 percentage points, and has slowly recovered since then, each time by a quarter of a percentage point, under Yellen and Powell. Currently, the federal funds rate is between 2% and 2.25%. The Fed is expected to raise its rates another quarter of a point in December.

It's still low – before the financial crisis of 2006, they were more than 5%. In the early 1980s, the Fed had raised rates up to 20% to fight inflation.

In a speech delivered to the New York Economic Club on Wednesday, Powell said the rates were "still low by historic standards" but "just below the wide range of level estimates". which would be neutral for the economy ". reaction.

Why Trump wants Powell to keep his rates low

Trump spent much of his presidency boasting about the rebound in the stock markets (which has recently weakened) and promising a sharp acceleration of economic growth. The rise in interest rates is a threat to that.

When interest rates rise, this can scare the stock market because it makes more attractive other categories of investments – such as bonds and CDs. Zero and super low interest rates in recent years have made stocks the only place where investors can earn money, and the fear is that when the Fed raises its rates, investors start to look elsewhere. Higher rates make borrowing more expensive and slow down the flow of credit to businesses and individuals, which could weigh heavily on equities.

Rate hikes can also slow economic growth by making credit more expensive. The economy relies on indebtedness to finance all kinds of growth patterns, from shopping for vacation to consumers, to mortgages, and the more expensive it is to get credit, the lower the cost.

During his presidential campaign, Trump often criticized the Fed, claiming that it was maintaining artificially low interest rates in order to support the Obama economy. In a way, he seems to have telegraphed what he expects Powell to do for him.

He is also looking for someone to point fingers when the stock market starts to gain height or if economic growth slows down.

"What we're seeing here, is that Trump needs to say that when things are going well, that's Trump, and when they're not, that's somebody's on the other, "said Peter Conti-Brown, assistant professor and historian of finance at the Wharton School. at the University of Pennsylvania. "That's something else, in this case, would be Jerome Powell and the Federal Reserve."

Trump may not be wrong to question what the Fed is doing. But the way he does it is weird.

The Fed has a difficult balance to reach: raise enough interest rates to avoid overheating the economy, but avoid doing too much to not surprise the markets or cause a recession. Fed Vice President Richard Clarida said in a recent interview with CNBC that Powell compared the Fed's plot to a dark room. "Especially without shoes, you want to go slowly so you do not bang your toe".

And many people think that the Fed could act too aggressively right now.

"This is a live debate and the Fed is unaware of a Platonic ideal on what interest rates should be," Conti-Brown said. "They do not have this information, they guess it, and they will be the first to admit it."

But the Fed is supposed, at least theoretically, to be an independent body that frees monetary policy from any political influence. It's not uncommon for the presidents to try to tip the balance on one side or the other – Lyndon Johnson and Henry Truman clashed at the central bank – but most of the cajolings were held behind closed doors, especially since Bill Clinton, said Binder.

"Most presidents do this only when the economic situation is difficult, when they want a rate cut and the Fed sees the need to tighten rates," she said. "Trump complains when the economy is doing pretty well, at least on the surface."

In fact, Trump's policies of cutting $ 1.5 trillion in taxes and increasing the budget deficit could push the Fed to act more aggressively. Tax cuts and spending are supposed to stimulate the economy and could therefore affect the Fed's decision to raise rates to slow down the situation.

"In a sense, the Fed follows Trump here," said Conti-Brown.

Of course, Trump did not have to choose Powell.

He could have renamed Yellen, who was nominated by President Barack Obama in 2012, as it was common for presidents to rename the Fed presidents chosen by their predecessors. Yellen has proven to be a staunch supporter of the Fed, he is more qualified than Powell and has played a key role in managing the US economy during the post-recession recovery. But Trump did not want it. (The Washington Post reported that one of the issues raised by Trump with Yellen was that at 5 feet 3 inches she was too small.)

It is unclear whether Powell's shares are very different from Yellen's, as both are considered rather accommodating – which means they prefer more flexible policies, such as low interest rates. And the Fed is on the path of the current rate hike for some time.

"What the Fed is doing here is part of a long-term trend that began in earnest in 2015 but has also been telegraphed into the decision-making process as of 2012," Conti-Brown said.

But Trump wanted to bring in his own guy and, apparently, with that, he was expecting to be loyal – as he had done with former Attorney General Jeff Sessions and the former director from the FBI, James Comey. Kevin Warsh, a former Fed governor who was one of Powell's opponents to replace Yellen, said in an interview this year that the Fed's independence was "probably not an obvious feature for the president."

We do not know what Trump could have said to Powell in terms of expectations before appointing him, but it is obvious that the president is not satisfied with the way this has been done.

"It seems to believe that Powell would not raise rates, nor reduce the cost of credit," Binder said. "I do not know exactly where Trump got this idea, or whether it's part of his expectations of what it means to be a trusted Trump appointee."