Is Trump Right About the Fed?
Another day, another bizarre chapter in the fraught relationship between President Trump and Federal Reserve Chairman Jerome “Jay” Powell.
Sometimes it’s hard to keep up with this particular soap opera. One day Trump rants about Powell’s unwillingness to start cutting interest rates, the next day he backs down… and the day after that he reverts to bashing the Fed chief.
All the drama aside, however, it’s absolutely worth asking if Trump is right about Powell. That is, should the Fed already be cutting interest rates to stimulate the economy?
After all, the Commerce Department recently reported that the economy contracted by 0.3% in the first quarter. And when the economy starts shrinking, the Fed is supposed to do something, right?
Well, it’s complicated…
Dual Mandate
First of all, despite the negative first quarter GDP reading, the economy still looks relatively healthy. In fact, Wall Street shrugged off the GDP figure, attributing it to a surge of imports by firms trying to front-run Trump’s tariffs.
That was the Fed’s take, too. “Although swings in net exports have affected the data, recent indicators suggest that economic activity has continued to expand at a solid pace,” the Fed’s Wednesday statement said.
Plus, hiring was robust in April, with 177,000 new jobs created and the unemployment rate still at a very low 4.2%. And the most recent reading of the Personal Consumption Expenditure Index – the Fed’s preferred inflation measure – showed that prices have largely stabilized.
So right now, the labor market is strong and inflation is under control.
And that’s exactly what the Fed aims for. Its dual mandate is to achieve both stable prices and maximum employment (it also aims for moderate long-term interest rates, which are good for an economy).
If all is going well, those two primary goals are complementary. An economy with low and stable inflation provides the right economic conditions for economic prosperity and a strong labor market.
But often the two goals are at odds. If the labor market is too tight (more open jobs than workers to fill them), companies will bid up wages to attract workers, which causes inflation. In such a scenario the Fed would raise rates to bring inflation down, even though doing so could raise the unemployment rate.
In response to runaway inflation in the late 1970s, Fed Chief Paul Volcker hiked the Fed Funds Rate to 20% in 1979-1980. That pushed the unemployment rate above 10% and led to a recession. Still, “Tall Paul” – the man was 6 feet 7 inches – was able to wrench the corrosive inflation out of the economy.
Balance Is Key
But today, with unemployment low and inflation largely under control, there’s no reason for the Fed to cut or raise rates. That’s why it stood pat at last week’s meeting of its interest rate setting committee.
But what about the future, and most important, the impact of the tariffs?
Well, it’s not clear what the impact will be. The tariffs could slow the economy and lift unemployment, they could send inflation higher, or they could do both.
And that’s the Fed’s worry.
Last week’s Fed statement said exactly that. “The Committee is attentive to the risks to both sides of its dual mandate and judges that the risks of higher unemployment and higher inflation have risen.”
So, until Powell and his army of Fed economists get some sort of reading on the impact of the tariffs, they seem to be determined to sit on their hands.
That said, the futures market does predict the Fed will cut its benchmark interest rate later this year, perhaps by as much as three-quarter of a percentage point by year end.
The current Fed Funds rate is in the range of 4.25% to 4.5%, and the futures market assigns just a 10% probability that the rate will be 4% or higher by year end. The greatest probability – about 37% right now – is that that range will be 3.50% to 3.75% by year end.
Trump, however, seems to be worried that a Fed cut during the second half of the year will be too late to counter the impact of his tariffs. He wants preemptive cuts, and he wants them now.
But Powell’s strategy of patience is probably the wiser one, as the Fed could make the impact of the tariffs – whatever that turns out to be – much worse if it guesses wrong now.
Trump would disagree, of course. And he’s letting everyone know it.
“You’re not supposed to criticize the Fed,” Trump said in a speech last Wednesday. “You’re supposed to let him do his own thing, but I know much more than he does about interest rates.”
Last week Powell had a funny rejoinder to that comment. Asked about the White House and Congressional fiscal policy, he answered that “they don’t need our advice on how to do fiscal policy… any more than we need their advice on monetary policy.”
Well put.
This article was originally published on this site
