Using monetary policy as a political weapon
By Scott Sumner
Former New York Fed President William Dudley has received a great deal of well-deserved criticism for these remarks:
“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,” Dudley wrote, referring to Fed Chair Jerome Powell. “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.”
Although Dudley is viewed as a foe of Trump, their views on monetary policy are actually quite similar. Both favor a Federal Reserve that advances their preferred political goals.
As President, Trump has frequently asked the Fed to help him in his trade war with China by cutting interest rates. You might argue that this is not being political, as Trump’s always been a fan of low interest rates. Here’s Trump in May 2016:
“I happen to be a low-interest rate person unless inflation rears its ugly head, which can happen at some point,” Trump told The Wall Street Journal in May. The mogul went on to tell the paper that high rates make American exports less competitive, while also increasing our country’s borrowing costs.
In that case, there is indeed nothing wrong with Trump calling for low interest rates today. Rather, the real problem occurred in September 2016, when Trump objected that low interest rates were improving the US economy and thus making President Obama look good:
On Monday, Donald Trump said that Janet Yellen is keeping interest rates low so that the stock market won’t crash — and that she should be “ashamed of herself” for doing so.
“She’s obviously political and doing what Obama wants her to do,” Trump said of the Federal Reserve chair on CNBC, before explaining that the central bank would not raise interest rates because it didn’t want the economy to implode on this president’s watch.
Matt Yglesias pointed to the obvious problem with Trump’s remarks:
[T]he way low interest rates are allegedly helping Obama is by improving economic conditions. But improving economic conditions is what the Fed is supposed to do. Why would they be ashamed?
In a more recent post, Yglesias observed that this sort of attempt to politicize of monetary policy is not new:
And, indeed, back in 2010, Bush-appointed Fed Governor Kevin Warsh openly called for the Fed to take a more punitive approach to the Obama administration’s policies. Former St. Louis Fed President William Poole made the same argument in a piece for the Cato Institute in 2012.
At around the same time, the European Central Bank was actually putting these ideas into practice in an extremely dangerous way.
As Philipp Rösler, at the time vice chancellor and economics minister of Germany, explained, “if you take away the interest rate pressure on individual states, you also take away the pressure for them to reform.”
And of course there are famous examples involving Presidents Johnson and Nixon. Nonetheless, the Dudley/Trump view of monetary policy is especially dangerous. While it is harmful to ask the Fed to make your administration look good by improving the economy (at the cost of future pain), and even more harmful to try to use monetary policy to discourage what you see as a bad policy, it is especially dangerous to ask the Fed to intentionally damage the economy to achieve your own political goals.
That is how banana republics behave.
PS. It’s possible to play words games and suggest that the Trump and Dudley comments don’t mean what they seem to mean. Sorry, but you’ll never convince me on that point. I’m quite confident that I know exactly what these two meant.