Wednesday , December 19 2018
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Will the Fed Trump the President or vice versa?

Summary:
Donald Trump has been at it again, criticising the Fed over its policy of gradually normalising interest rates.  Commentators are wondering what exactly the Fed will do in response. Some worry that the Fed will cave in;  and indeed interpret a fall in the dollar coincident with Trump’s remarks as suggesting that this view is shared widely in the markets. Why would it cave in?  Perhaps to give itself an easy life in its interactions with Congress;  to reduce the likelihood of future campaigns to ‘Audit’ it, or change its mandate.  This seems highly unlikely.  The returns to loyalty appear too uncertain and thin.  Powell himself might well be content with only one term, working hard at a job with low pay.  The White House has almost no influence over most of the other FOMC

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Donald Trump has been at it again, criticising the Fed over its policy of gradually normalising interest rates.  Commentators are wondering what exactly the Fed will do in response.

Some worry that the Fed will cave in;  and indeed interpret a fall in the dollar coincident with Trump’s remarks as suggesting that this view is shared widely in the markets.

Why would it cave in?  Perhaps to give itself an easy life in its interactions with Congress;  to reduce the likelihood of future campaigns to ‘Audit’ it, or change its mandate.  This seems highly unlikely.  The returns to loyalty appear too uncertain and thin.  Powell himself might well be content with only one term, working hard at a job with low pay.  The White House has almost no influence over most of the other FOMC appointments.

Another possibility is that the Fed would raise rates faster than it intended previously, just to make a point.  A concern is that the fall in the dollar might prompt it to do just that.  A show of force to demonstrate that the Fed sets rates, and not the White House.  I doubt it would do this.  It would be hard to argue that this was consistent with its mandate.  Short term macro performance as judged by the mandate would be being set aside for a very uncertain return in terms of anchoring expectations around the event that the Fed is doing its job unhindered.

Raising rates might nonetheless be the consequence of the President trying to pressure the Fed into reducing them.  If this did/does produce a higher probability of lower rates in the minds of market participants, higher rates would be necessary to choke off the lower longer term real rates, anticipated higher spending and inflation that would follow.    Tighter policy would be needed until enough evidence has accumulated for those who had up-weighted the event that the Fed would cave in to revise their expectations again.  From this perspective, if you are a President who knows that the Fed is unlikely to listen, trying to make them hear you can be highly counter-productive.

From the perspective of the Fed, and the institution of central bank independence, an episode wherein the Fed is shown to carry on doing its job [and raising rates in response might well, as I explained, constitute doing its job] might be beneficial, reinforcing the belief, or reminding observers, that it takes more than the disapproval of a President to taint monetary policy.

A weaker dollar and lower expected future rates – which seemed to follow from Trump’s remarks – may not necessarily imply that markets think the Fed is going to cave in, however.  That could simply point to worries about economic policy generally, deriving from unpredictability or incompetence of the White House, and a fall in spending [and thus inflation and the Fed policy rate] that would follow.

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Tony Yates
Economist. Consulting, lecturing, a book. Ex Prof at Bham, Ex BoE staffer. Macro, policy, monetary econ, occasional nonsense.

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