By Austin Cherry
President Donald Trump is quietly preparing to use the nation’s central bank as a scapegoat if the economy turns sour before his 2020 re-election bid. In recent months, President Trump has commented that he is “not thrilled” with the Federal Reserve’s interest rate policy, and in the process, has threatened the Federal Reserve’s longstanding independence. If he continues to threaten the independence of the Federal Reserve, there will be one certain loser–the American public.
Since the 1970s, the Federal Reserve’s independence has been a pillar of the nation’s economic stability. When inflation reached double digits in the late 1970s and early 1980s, the Federal Reserve under Chairman Paul Volcker decisively boosted the Federal Funds rate to a high of 20%. Although it was wildly unpopular and resulted in protests, this temporarily painful policy quickly pulled inflation down to normal levels. In response to the 9/11 terrorist attacks, the Federal Reserve decreased the Federal Funds Rate by 175 basis points in the next 3 months. The Federal Reserve also provided liquidity to the financial system through two avenues–the discount window and the purchase of Treasury securities. The discount window, which allows the Federal Reserve to act as the “lender of last resort” by making loans to banks, allowed banks to continue providing loans to their customers even as these customers faced declining asset values. Similarly, the purchase of Treasury securities from banks increased the amount of cash in banks and in the economy as a byproduct. By taking these aggressive actions, the nation’s central bank was able to fend off what could have been an extreme economic slowdown. In the wake of the financial crisis of 2008, the Federal Reserve quickly decreased the federal funds rate, bought mortgage-backed securities from banks, and used its discount window to lend to insurance companies, security dealers, and traditional banks. Without these unprecedented moves, the financial crisis of 2008 would have almost certainly destroyed the nation’s financial system and resulted in a deep economic depression.
The value of the Federal Reserve’s independence is twofold, then. First, the Federal Reserve can take actions that are politically unpopular in order to protect the stability of the United States economy. Second, the Federal Reserve can act quickly and decisively to stabilize economic conditions. In contrast, the White House and its executive agencies, including the Treasury Department, are political entities and thus are wary of taking unpopular actions even when they may be optimal from a policy perspective. Additionally, the Treasury Department must often go through the plodding legislative process to gain the authority to take actions to stabilize the economy. This most notably occurred during the Financial Crisis, when the Emergency Economic Stabilization Act of 2008, which authorized the TARP program, was initially voted down by the House of Representatives before finally being passed after the addition of several unrelated amendments. While the White House was locked in a legislative battle to gain the authority to purchase toxic assets, the Federal Reserve was already lending to eligible institutions with toxic assets as collateral. To put it simply, the Federal Reserve’s status as an independent, quasi-governmental organization makes it nimbler and quicker to respond to financial panics.
In the current economic climate, unemployment rests at 3.9%, and inflation is at 2.7% but is expected to accelerate with the combination of tight labor conditions and the trade war with China. These conditions lead to the logical conclusion that it would be prudent to increase the Federal Funds rate to prevent overheating and to provide more monetary policy “ammo” for the next period of economic weakness. The Federal Reserve has taken this approach, as it has increased its benchmark rate three times this year and is widely expected to raise rates again in December.
In recent months, President Trump has broken with a long-standing presidential norm of avoiding commentary on monetary policy decisions by the Federal Reserve. In June, President Trump tweeted that “the U.S. is raising rates while the dollar gets stronger and stronger with each passing day – taking away our big competitive advantage… we are raising rates – Really?” In an August interview with Reuters, President Trump doubled down, saying that he was “not thrilled” with the interest rate hikes under his appointee Powell and suggesting that he “should be given some help by the Fed.”
President Trump is ever the political opportunist, and it is easy to see his strategy with these criticisms. If the economy falls into a recession in the next two years and especially before his 2020 re-election bid, Trump will deflect all blame onto the rate hikes by the central bank. In the worst-case scenario, Trump may attempt to strip the Federal Reserve of its statutory independence. Although this is unlikely, less dramatic measures such as appointing members of the Board of Governors who are willing to bend to his will remain a definite possibility. Even if President Trump takes no concrete actions to strip the Federal Reserve of its independence, a President’s words have immense power, and markets would sour on the dollar if its most important caretaker was subject to repeated onslaughts by the nation’s most powerful man. Additionally, the Federal Reserve may become weary of making politically unpopular decisions in the interest of economic stability if it is subject to unrestrained criticism by the President and other politicians.
The Federal Reserve’s independence, which allows it to make politically unpopular decisions and to take quick and decisive actions to promote economic stability, has been called into question by President Trump. Prices in the United States have been remarkably stable over the past 40 years under the steady hand of the Federal Reserve, and American consumers have been the clear beneficiaries of these conditions. President Trump’s criticisms have thus far been limited to tweets and off the cuff comments in interviews, but if the economy slows before his re-election bid, his criticism will undoubtedly intensify. If President Trump chooses to go to battle with the Federal Reserve, he may “win” as the Federal Reserve would almost surely become a weaker institution. However, his insistence that he should be “given some help” by the Federal Reserve makes a mockery of the Federal Reserve’s mission. If an informal mandate of “giving help” to the President is added to the Federal Reserve’s mandate of maximum employment and stable prices, ordinary Americans will pay the price.