Don’t Politicize The Federal Reserve.

A former Federal Reserve officials argues that the Fed should not lower interest rates to compensate for the impact of the President's trade war, potentially leading to his defeat in the election. This is an incredibly bad idea.

Bill Dudley, a research fellow at Princeton University’s Center for Policy makes a provocative argument about Federal Reserve policy in advance of the election:

U.S. President Donald Trump’s trade war with China keeps undermining the confidence of businesses and consumers, worsening the economic outlook. This manufactured disaster-in-the-making presents the Federal Reserve with a dilemma: Should it mitigate the damage by providing offsetting stimulus, or refuse to play along?

If the ultimate goal is a healthy economy, the Fed should seriously consider the latter approach.

The Fed’s monetary policy makers typically take what happens outside their realm as a given, and then make the adjustments needed to pursue their goals of stable prices and maximum employment. They place little weight on how their actions will affect decisions in other areas, such as government spending or trade policy. The Fed, for example, wouldn’t hold back on interest-rate cuts to compel Congress to provide fiscal stimulus instead. Staying above the political fray helps the central bank maintain its independence.

So, according to conventional wisdom, if Trump’s trade war with China hurts the U.S. economic outlook, the Fed should respond by adjusting monetary policy accordingly — in this case by cutting interest rates. But what if the Fed’s accommodation encourages the president to escalate the trade war further, increasing the risk of a recession? The central bank’s efforts to cushion the blow might not be merely ineffectual. They might actually make things worse.

(…)

[T]he Fed could go much further. Officials could state explicitly that the central bank won’t bail out an administration that keeps making bad choices on trade policy, making it abundantly clear that Trump will own the consequences of his actions.

Such a harder line could benefit the Fed and the economy in three ways.

First, it would discourage further escalation of the trade war, by increasing the costs to the Trump administration. Second, it would reassert the Fed’s independence by distancing it from the administration’s policies. Third, it would conserve much-needed ammunition, allowing the Fed to avoid further interest-rate cuts at a time when rates are already very low by historical standards.

I understand and support Fed officials’ desire to remain apolitical. But Trump’s ongoing attacks on Powell and on the institution have made that untenable. Central bank officials face a choice: enable the Trump administration to continue down a disastrous path of trade war escalation, or send a clear signal that if the administration does so, the president, not the Fed, will bear the risks — including the risk of losing the next election.

There’s even an argument that the election itself falls within the Fed’s purview. After all, Trump’s reelection arguably presents a threat to the U.S. and global economy, to the Fed’s independence and its ability to achieve its employment and inflation objectives. If the goal of monetary policy is to achieve the best long-term economic outcome, then Fed officials should consider how their decisions will affect the political outcome in 2020.    

Before addressing the merits of Dudley’s argument, it’s important to take note of both who Dudley is and what he’s saying. Prior to taking his current position at Princeton, Dudley was the head of the Federal Reserve Bank of New York from 2009 through 2018. He took up that position when the previous head, Timothy Geithner left to become Barack Obama’s Secretary of the Treasury and served in that capacity through the entirety of the Obama Administration and much of the first two years of the Trump Administration. As head of the New York branch of the Federal Reserve, he was effectively the second most influential member of the Federal Open Market Committee, the Federal Reserve Board committee that is largely charged with making the interest rate and other decisions that most directly impact American consumers and businesses. I point this out to make it clear that these ideas are coming from someone who had nine years of experience dealing with some of the most consequential economic decisions anyone in government can make, and that his experience dates back to the waning days of the Great Recession when Federal Reserve interest rate policy played an important, some would say crucial, role in preventing the economy from going over the cliff.

As Dudley well knows, Federal law basically obligates the Fed to set policy with two goals in mind. The first is to maintain stable interest rates and protect the value of the dollar worldwide. The second goal is the somewhat more difficult goal is to maintain economic growth, with a goal of aiming for what economists call “full employment.” These are sometimes contradictory goals, and the first is usually easier to accomplish than the second, but they are fairly straightforward and historically speaking, the Federal Reserve has done a fairly good job of achieving both of them. Of course that doesn’t mean perfection, as we learned during the inflation crisis of the 1970s, which was caused in no small part due to far too expansive monetary policy on the Fed’s part, and the Great Recession, the warning signs of which the Fed largely missed just like everyone else in government.

Now as far as what Dudley is proposing…….

The current Federal Reserve policy, which Fed Chairman Jerome Powell announced after the last FOMC meeting earlier this month, states that the Fed will take into account the impact of President Trump’s trade policies on the economy and that there may be additional interest rate cuts if it appears that those policies are slowing the economy down. Instead of doing this, Dudley argues, the FOMC should basically sit back and let the trade war do whatever it is going to do to the economy, even if that means tanking the economy. The reason for this? Because a recession or a slowing economy would probably make it less likely that President Trump is re-elected.

Slate’s Jordan Weisssman thinks Dudley is on precisely the wrong track:

Like many, the Fed’s ex-No. 2 is concerned that Trump’s trade war with China is undermining the U.S. economy—which it probably is—and thinks this “manufactured disaster-in-the-making presents the Federal Reserve with a dilemma: Should it mitigate the damage by providing offsetting stimulus, or refuse to play along?”

In other words: Should the Fed cut interest rates, as Donald Trump has been demanding, and risk encouraging him to escalate the trade war? Or should it leave them right where they are, even if it means the economy might fall into a recession?

To many, this is not a hard question. The Federal Reserve’s job, handed down by Congress, is to keep unemployment as low as possible while maintaining stable inflation. There is absolutely nothing in its mandate about discouraging politicians from embarking on a harebrained trade war. If Donald Trump wants to pursue a mutually destructive, tit-for-tat tariff battle with China, that’s his right as a duly-elected president. It’s the Fed’s responsibility to keep the economy afloat, or try to, in the meantime.

But Dudley doesn’t see things that way. He not only believes the Fed should leave rates be but that it should take a political stand on the issue. “Officials could state explicitly that the central bank won’t bail out an administration that keeps making bad choices on trade policy, making it abundantly clear that Trump will own the consequences of his actions,” he writes.

(…)

It is hard to overstate what a tremendously dangerous concept this is. Dudley is not talking about a conflict between two equal branches of government. If the economy crashes and Democrats don’t want to pass a stimulus because it might help Trump, that would be crappy and inhumane, but it’d also fundamentally be politics. Voters could decide who to hold accountable. Here, Dudley is effectively talking about an economic coup staged by a group of unelected technocrats. He doesn’t seem to be worried about the implications of this idea, because he feels the president has already politicized the central bank. “I understand and support Fed officials’ desire to remain apolitical,” he writes. “But Trump’s ongoing attacks on Powell and on the institution have made that untenable.” But that is absurd! The best way for the Fed to show it is not a political institution is to not act like a political institution, and intervene to help the economy when circumstances obviously dictate it.

And if the Fed did actually try to sway trade policy, or an election, it could easily lead to the end of its cherished independence. Republicans and Democrats might start appointing and confirming reliable partisans to the Fed who would do their best to manipulate policy to maximize their party’s electoral advantage, kneecapping the economy when the other guys are in power and pumping it up when their own presidents are in office. (Trump already tried this with Stephen Moore and Herman Cain, who thankfully weren’t confirmed.) Or Congress might decide to simply blow up the Fed’s current structure altogether to make it more politically accountable to the White House.

Given that Dudley is a powerful former leader, his op-ed is not merely ill-conceived, but outright dangerous. Trump and plenty of other Republicans are already prone to seeing deep state conspiracies hellbent on taking down the president where they almost certainly don’t exist.

They are already prone, for that matter, to hate the Fed. But given his previous position, it is not a crazy leap to think that Dudley is voicing thoughts that other people inside the central bank have entertained. Ironically, by mouthing off on the internet, Dudley may be putting even more pressure on Powell & co. to go along with Trump, lest they look like they’re plotting regime change. But even if they do, this op-ed will probably live on as proof among the president’s supporters that the swamp is out to get him.

I’m 100% with Weissman on this issue. At least in its modern form since the end of World War Two, the Federal Reserve has strived to be as apolitical as possible, and it’s clear that this is exactly what was intended went the system was created a century ago. It’s the reason, for example, why the terms of the Chairman and the members of the Board of Governors are staggered and longer than those of a President unless that President serves two terms. It’s also why the law makes it difficult to remove the Chairman or other appointed Fed officials. The danger otherwise would be that monetary policy could end up being a far more partisan issue, something that would have an impact on interest rates, the value of the dollar, and the state of the economy.

Dudley is suggesting that Powell and the Fed should toss seventy years of that apolitical tradition to the side in a way that would involve the Fed putting its thumb on the scale in favor of one side in a political argument. That would complicate the operations of the Fed for years to come and, as Weissman notes, could lead to a situation where the Federal Reserve becomes a partisan pawn used by both political parties to support their respective agendas. In addition to being a bad idea, such a development would likely have consequences for the nation and would lead to chaos in worldwide financial markets that would make any downturn worse.

Fortunately, it seems unlikely that Chairman Powell and other Fed officials are not inclined to listen to ideas like this. That’s fortunate because it would be potentially disastrous if they did.

FILED UNDER: Campaign 2020, Economics and Business, US Politics, ,
Doug Mataconis
About Doug Mataconis
Doug holds a B.A. in Political Science from Rutgers University and J.D. from George Mason University School of Law. He joined the staff of OTB in May 2010. Before joining OTB, he wrote at Below The BeltwayThe Liberty Papers, and United Liberty Follow Doug on Twitter | Facebook

Comments

  1. An Interested Party says:

    Of course, politicizing the Fed goes both ways…perhaps the trash in the White House should follow the same advice…

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  2. Kathy says:

    I agree.

    No question Trump, and his enablers and supporters, is taking a wrecking ball to the governing norms of the US. It’s not the Fed’s job to aid him by supplying explosives.

    Don’t forget, too, many on the right who want to abolish the Fed. This would help them in that goal.

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  3. Hal_10000 says:

    The rule with Trump is that he will happily shaft the future for the benefit of the president. The deficit, his environmental regs, etc. — all about benefiting the moment at the expense of the future. He wants the fed to pull out the stops to keep a recession from happening on his watch even if it means a bigger recession in the future. Because that will be someone else’s problem.

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  4. Just Another Ex-Republican says:

    The Constitution does not provide for any agencies like the Fed (or DOJ, or anything else) to be “outside politics”. It’s only custom and restraint that has made them quasi-independent from the executive they nominally report to. The Founders plan was “ambition countering ambition” and Congress being the most powerful branch. Alas, both of those concepts are now nothing but vague memories and academic subjects. Combined with parties that define themselves solely as supporting or opposing the President, and the pressure on the semi-independent agencies is inevitable. What the agency actually does is irrelevant; how it’s perceived as supporting or opposing the President defines how Congress (and much of the public) sees them, and independence is going down the tubes.

  5. Just Another Ex-Republican says:

    Additional: The coincidence of the Comey report coming out today is also striking. His original sin was jumping into politics to blast Clinton’s handling of emails. Democrats hated him and Trump and Republicans lauded him (at both the initial press conference and the October surprise Comey pulled). Then he stepped in to politics again to put his own judgement above all and arrange to leak the memos that lead to a special counsel. Suddenly Democrats love him and Republicans hate him.

    The truth is all 3 actions represented terrible judgement and he still won’t accept any responsibility for those actions (to judge by his tweets today). He’s almost single-handedly responsible for allowing Trump to convince voters a “deep state” exists and that the President should have more control over all agencies.

    So in relation to the Fed, Dudley no doubt has forgotten more about the economy than I will ever know, but this is horrifically bad political advice. The only chance these agencies have in today’s environment is to be vigilantly and scrupulously apolitical.

  6. gVOR08 says:

    Personally, I’d worry more about Trump, the PRESIDENT*, and Thom Tillis, sitting SENATOR, trying to influence the Fed than an academician, even if he is EX president of the NY Fed.

    The Fed may, or may not, be able to prevent a recession, but they probably can affect the timing. If the choice is only between recession now and recession after a Trump reelection, what legitimate purpose of the Fed is served by delay? Is the real question here whether the Fed should prop up the economy short term, or perhaps do what’s better in the long run. If Trump’s policies are a major threat to the economy, is it not bad policy to support them? Weissman’s argument fails on the realization that support of Trump’s actions will be seen, and should be, as just as political as opposing them.

    The Fed is orders of magnitude better than SCOTUS, but not entirely free of political influence. I believe there have been studies showing the Fed has cut rates to help Republican incumbents. Or, more diplomatically they seem maybe a little less sensitive to inflation and a bit more to employment late in Republican first terms.

    The current Federal Reserve policy, (…) will take into account the impact of President Trump’s trade policies on the economy and that there may be additional interest rate cuts if it appears that those policies are slowing the economy down.

    In other words they will prop up the economy before the election, for whatever reasons you care to attribute to them. And they’ve already made one rate cut to boost the economy short term.

    In that context I’m old enough to remember Volcker in the Reagan recession. He based all his decisions on the money supply. Using each month whichever measure of money and whatever interpretation allowed him to rationalize continuing the tight money policy he’d already decided on.

    However, this may all be moot. The Fed recently cut, hoping to provide short term boost. With the Federal Funds Rate at 2.25% the Fed just doesn’t have much to work with if they do wish to cut. And perhaps it would be wiser to save what little they’ve got until here’s a more immediate threat of recession?

  7. Just nutha ignint cracker says:

    First, it would discourage further escalation of the trade war, by increasing the costs to the Trump administration.

    With all due respect to Mr. Dudley and his expertise about the inner workings of the economy, I, personally, wouldn’t rely on this action having the effect suggested during a Trump administration. Just sayin’…

  8. Scott O says:

    I agree that this would not be a good idea but just wanted to note that Trump has tossed out seventy years of tradition that the president does not call the chairman of the federal reserve our enemy. That and many other things that Trump has done concerns me a lot more than what Bill Dudley has to say.

  9. gVOR08 says:

    @Kathy: @Just Another Ex-Republican: Being apolitical isn’t going to help anybody. Trying to refrain from giving them any pretense for bad action isn’t going to help anybody. GOPs will be asshats independent of any real or imagined action on the part of … liberals? democrats? dedicated public servants? What’s a good term for everyone not a RWNJ?

  10. Gustopher says:

    @gVOR08:

    If the choice is only between recession now and recession after a Trump reelection, what legitimate purpose of the Fed is served by delay?

    I believe their goal is to minimize recessions? That would encourage delay, so long as delay does not make the eventual recession worse?

    With no information as to whether pain today is better than pain tomorrow, choose tomorrow.

  11. Ken_L says:

    A complicating factor is that thanks to Trump’s refusal to follow basic ethical requirements, he stands to benefit personally to the tune of millions of dollars a year from the lower interest rates he is trying to intimidate the Fed into delivering. And knowing Trump as we do, it is by no means inconceivable that this is his sole reason for caring about them. The solution lies not with Powell but with Congress and the impeachment power, but of course Republicans have made it clear they have no intention of protecting the integrity of the nation’s public institutions.

  12. Tyrell says:

    @Scott O: But there have been presidents, senators, and members of Congress who have been aggravated, to put it mildly, by policies of the Federal Reserve chairman that kept interest rates high. Add to that back in the ’70’s the average citizens sat and watched in consternation as Chairman Volcker and others put buying a home out of their reach. 10%+ mortgage rates. “Tight credit”. Home and commercial building construction came to a halt.
    1970’s: a bad time. High interest rates, high unemployment, high prices, gas “shortage”, and polyester clothes.

  13. Scott O says:

    @Tyrell: The people that I talk to everyday don’t want to hear about what Tyrell thinks. They’re busy working and when they’re not working they’d rather talk about water skiing or gathering black berries. They tell me that they prefer comments from those who are living in the present.