It's getting harder to influence the Fed
By Scott Sumner
The Economist has an interesting article discussing central bank independence:
Mr Trump has already appointed a majority of the sitting governors of the Federal Reserve Board. Had he kept his mouth shut but appointed more doveish types, he might have achieved the same end without the outcry.
That sounds reasonable at first glance, but there are some tricky issues here that need to be disentangled. First of all, what is “the same end” that President Trump achieved? Conventional wisdom says that he failed to get Jerome Powell to adopt a low interest rate policy. Yet the article refers to a dovish policy, which might or might not be the same thing.
Also note that while Trump replaced Janet Yellen with a slightly more hawkish person, Fed policy has actually become more dovish under Powell’s leadership, as NGDP growth has accelerated sharply since 2016. (Inflation has increased more modestly.) Recall that Ben Bernanke suggested that interest rates were not the way to judge the stance of monetary policy; rather we should look to NGDP growth and inflation. He’s right.
The ironies keep piling up. Trump says he’s a “low interest rate guy”, and everyone seems to assume that he favors easy money. On any given day those two objectives line up. But over the months and years they move in opposite directions. Easier money leads to faster inflation and NGDP growth, and higher interest rates. So what does Trump “truly favor”? Hard to say. It’s not clear that he’s even thought about this distinction. Indeed even well informed people often gloss over this issue.
And it gets even more complicated when you consider the Fed’s inflation target. What does it mean to talk about hawks and doves in an institution that is committed to a 2% inflation target? Is it likely that a “dove” like Janet Yellen would have pushed inflation up to 3%, or higher? That sort of outcome was plausible when President Nixon was pressuring Arthur Burns back in the early 1970s, but today it seems highly implausible.
Much of the discussion of Fed interest rate policy is misleading. Under a 2% inflation target, any victory for the hawks or doves is fleeting. They can nudge rates higher or lower, but unless they are willing to shift the inflation target down to 1% or up to 3%, any success will be temporary. A rise in rates will slow the economy, forcing a subsequent cut in rates. You see that in the way the yield spread responded to last month’s Fed announcement. Short-term rates rose and longer-term rates fell.
Trump appointed a slightly more hawkish Fed chair, who has delivered a somewhat more dovish policy, which is considered by most pundits to be a somewhat more hawkish policy. In such a confusing world, how likely is it that Trump will get what he really wants? And what does he really want? A slow growing low interest rate economy like Japan, or a higher interest rate faster growing economy like the US? Your guess is as good as mine.
The markets are now scaling back their estimates for future rate increases, due to slower expected NGDP growth. Is that a victory for Trump’s pressure tactics, pushing the Fed toward lower rates? Or a failure–pushing the Fed toward tighter money?