WASHINGTON — A former top Federal Reserve official implied that the central bank should consider allowing President Trump’s trade war to hurt his 2020 election chances, an assertion that drew a firestorm of criticism and a rare pushback from the Fed itself.
William Dudley, the former president of the Federal Reserve Bank of New York and now a research scholar at Princeton University, said in a Bloomberg Opinion piece that “Trump’s re-election arguably presents a threat to the U.S. and global economy.” Mr. Dudley added that “if the goal of monetary policy is to achieve the best long-term economic outcome, then Fed officials should consider how their decisions will affect the political outcome in 2020.”
It is a controversial statement, particularly coming from an official who ranked among the Fed’s most powerful policymakers as recently as 2018. It also comes at a sensitive moment for the Fed, which has been under attack from Mr. Trump and trying to assert its independence from the White House and politics in general.
“The Federal Reserve’s policy decisions are guided solely by its congressional mandate to maintain price stability and maximum employment,” Michelle Smith, a Fed spokeswoman, said when asked about the column. “Political considerations play absolutely no role.”
Mr. Trump has waged a yearlong campaign to pressure the Fed to cut rates, accusing the central bank of hurting the economy by keeping rates too high and putting the United States at a disadvantage to other nations, like China and Germany.
“The Federal Reserve loves watching our manufacturers struggle with their exports to the benefit of other parts of the world,” Mr. Trump said in a tweet on Tuesday. “Has anyone looked at what almost all other countries are doing to take advantage of the good old USA? Our Fed has been calling it wrong for too long!”
The attacks have put the Fed on the defensive, prompting top officials including Jerome H. Powell, the Fed chair, to insist that the central bank sets policy to achieve economic goals without taking politics into account.
The Fed cut rates for the first time in more than a decade in July and has kept the door open to future cuts, with Mr. Powell saying the central bank is prepared to act to protect the economy against slowing global growth and as Mr. Trump’s trade fights stoke uncertainty.
Mr. Dudley essentially said the Fed should wade into politics, arguing that the central bank should consider the political ramifications of the policy decisions it makes. By lowering interest rates to offset economic harm caused by Mr. Trump’s trade war with China, Mr. Dudley said the central bank could give the White House room to ramp up trade tensions.
“The central bank’s efforts to cushion the blow might not be merely ineffectual,” he wrote. “They might actually make things worse.”
Fed watchers responded to Mr. Dudley’s piece with widespread concern, asserting that it could feed conspiracy theories that the central bank is trying to influence political outcomes.
“The Fed for decades has scrupulously avoided doing that, and has tried to avoid giving that perception,” said Adam Posen, the president of the Peterson Institute for International Economics. “And this isn’t some ‘deep state’ fake: They genuinely don’t want to get into it, because ultimately they are accountable to Congress.”
Mr. Trump announced an escalation of the trade war with China just a day after the Fed cut rates in July, and the concern that Fed policy is enabling the tariffs is often repeated by analysts. Michael Strain at the American Enterprise Institute said it was a valid point to raise and consider.
But Mr. Strain pushed back against the idea that the Fed’s policymakers should try to guide political outcomes.
“It’s wildly irresponsible,” he said. “The Fed is not elected; it is appointed. It has a responsibility to adhere to a narrow reading of its mandate.”
The central bank’s leadership consists of 12 regional presidents, who are selected by businesspeople and community leaders from their districts and who share four annually rotating votes on interest rates. The New York Fed president is the most powerful regional leader and has a constant vote on policy.
The rate-setting committee also includes seven governors who are nominated by the president and confirmed by the Senate. Only five of those positions are currently filled, although Mr. Trump has said he intends to nominate another two members to the Fed.
The Fed does not answer to the White House by design: It is removed from politics so that it will make better long-term decisions for the economy, rather than trying to goose the economy going into election years. It is, however, responsible to Congress, which can change the rules that govern it.
That insulation has, historically, helped to fuel criticism that the Fed is removed from the public and in the pocket of bankers. The central bank has long been the target of conspiracy theories, and popular books about it have borne titles like “Secrets of the Temple.”
More recently, the president has placed the central bank firmly in political cross hairs. In a Twitter post last week, he asked whether Mr. Powell or President Xi Jinping of China was a “bigger enemy” of the United States. Mr. Trump has reportedly considered firing or demoting Mr. Powell in the past, and he recently told reporters that he would accept Mr. Powell’s resignation if it were offered.
Despite that pressure campaign, Fed officials have repeatedly pushed back against the idea that they would in any way take the White House’s comments or potential actions into account when setting policy.
“We’re never going to take political considerations into account or discuss them as part of our work,” Mr. Powell said at a news conference in January. “We’re human. We make mistakes. But we’re not going to make mistakes of character or integrity.”
Despite gyrations on Wall Street this week and an associated rise in recession fears, Donald Trump is still ballyhooing the state of the U.S. economy. In private, however, the President sounded “nervous and apprehensive” when he called a number of business leaders and financiers from his New Jersey golf club to get their opinions, the Washington Post reported.
Small wonder. With his personal-approval ratings stuck in the low forties, Trump’s 2020 reëlection campaign hinges on a healthy economy. He can be pretty confident that his core supporters will turn out for him, but he also needs to win over some less committed voters. His pitch to them is one that the British Conservative Party used successfully in 2015, during a general election, when it talked up the U.K. economy and issued dire warnings about the consequences of a victory for the opposition Labour Party.
One of the Conservatives’ campaign slogans was “DON’T LET LABOUR WRECK IT.” Substitute “THE DEMOCRATS” for “LABOUR” and you have Trump’s campaign strategy in a nutshell. Addressing a campaign rally in New Hampshire on Thursday night, he portrayed the Democratic candidates for President as “a bunch of socialists or communists” and asked the crowd, “Does anybody want to pay a ninety-five-per-cent tax?” He also suggested that a Democratic victory would lead to a crash in the stock market, adding, “You have no choice but to vote for me, because your 401(k), everything is going to be down the tubes. Whether you love me or hate me, you have got to vote for me.”
The mere fact that Trump’s strategy is based on scaremongering (under Barack Obama, the Dow more than doubled) and outright lies (Joe Biden is a socialist?) doesn’t mean that it can’t work. In 2015, the British economy wasn’t doing great at all. Held back by five years of Conservative austerity policies, it hadn’t even fully recovered from the Great Recession. But the Conservatives, aided by their allies in the British media, managed to raise enough doubts about Labour’s economic competence to gain an over-all majority in the House of Commons. As long as the U.S. economy looks strong, the possibility of something similar happening in November, 2020, can’t be ruled out entirely, despite Trump’s unpopularity.
But, if the economy turns south between now and the election, Trump will almost certainly be defeated, and he knows it. Hence his delay, earlier this week, on expanding tariffs on Chinese imports, and his increasingly frantic efforts to scapegoat the Federal Reserve and its chairman, Jerome Powell. As the Dow plunged on Wednesday, Trump took to Twitter, calling Powell “clueless” and retweeting guests on Fox Business who were criticizing the Fed’s recent policy moves.
In the two days since the big fall in the stock market, we’ve received some new economic data, and it has been mixed. On Thursday, the Commerce Department reported that retail sales expanded by 0.7 per cent in July, the strongest figure since March. Economists responded by raising their estimates of third-quarter G.D.P. growth to about two per cent. That’s a long way short of the four-per-cent growth that Trump promised, but it’s also well above recession levels.
At the same time, the Fed confirmed that the manufacturing sector is in a slump. Manufacturing output fell 0.4 per cent in July, the central bank said, and it is now about 1.5 per cent below its December, 2018, level. For a President who promised to restore manufacturing to its former position of prominence, that can hardly be reassuring. Neither can the news, on Friday, that the University of Michigan’s survey-based index of consumer confidence fell sharply in August, reaching its lowest level since 2016.
The fall raised concerns about whether strong consumer spending will continue to underpin the economy, and it also illustrated that Trump’s aggressive tactics in the trade war are backfiring. “Consumers strongly reacted to the proposed September increase in tariffs on Chinese imports, spontaneously cited by 33% of all consumers in early August,” Richard Curtin, the chief economist at the Michigan survey, noted. The White House has now postponed the higher tariffs until December. That may reassure some consumers, but this week’s fluctuations in the stock market are likely to add to their jitters.
To be sure, none of this means that a recession is imminent. Most economists are predicting that the G.D.P. will continue to rise, albeit at a modest pace. Citing continued growth in jobs and household incomes, Curtain said “it is likely that consumers will reduce their pace of spending while keeping the economy out of recession at least through mid 2020.” The most recent statements from the Fed indicate that it agrees with this assessment.
Despite all his bluster, Trump seems spooked. According to the Washington Post report, he has been “telling some confidants that he distrusts statistics he sees reported in the news media and that he suspects many economists and other forecasters are presenting biased data to thwart his reelection.” These sound like the ravings of an egomaniac who sees the world closing in on him.
The smart money thinks Trumponomics is a flop.
Last year, after an earlier stock market swoon brought on by headlines about the U.S.-China trade conflict, I laid out three rules for thinking about such events.
- First, the stock market is not the economy.
- Second, the stock market is not the economy.
- Third, the stock market is not the economy.
But maybe I should add a fourth rule: The bond market sorta kinda is the economy.
An old economists’ joke says that the stock market predicted nine of the last five recessions. Well, an “inverted yield curve” — when interest rates on short-term bonds are higher than on long-term bonds — predicted six of the last six recessions. And a plunge in long-term yields, which are now less than half what they were last fall, has inverted the yield curve once again, with the short-versus-long spread down to roughly where it was in early 2007, on the eve of a disastrous financial crisis and the worst recession since the 1930s.
Neither I nor anyone else is predicting a replay of the 2008 crisis. It’s not even clear whether we’re heading for recession. But the bond market is telling us that the smart money has become very gloomy about the economy’s prospects. Why? The Federal Reserve basically controls short-term rates, but not long-term rates; low long-term yields mean that investors expect a weak economy, which will force the Fed into repeated rate cuts.
So what accounts for this wave of gloom? Much though not all of it is a vote of no confidence in Donald Trump’s economic policies.
You may recall that last year, after a couple of quarters of good economic news, Trump officials were boasting that the 2017 tax cut had laid the foundation for many years of high economic growth.
Since then, however, the data have pretty much confirmed what critics had been saying all along. Yes, the tax cut gave the economy a boost — a “sugar high.” Running trillion-dollar deficits will do that. But the boost was temporary. In particular, the promised boom in business investment never materialized. And now the economy has reverted, at best, to its pre-stimulus growth rate.
At the same time, it has become increasingly clear that Trump’s belligerence about foreign trade isn’t a pose; it reflects real conviction. Protectionism seems to be up there with racism as part of the essential Trump. And the realization that he really is a Tariff Man is having a serious dampening effect on business spending, partly because nobody knows just how far he’ll go.
To see how this works, think of the dilemma facing many U.S. manufacturers. Some of them rely heavily on imported parts; they’re not going to invest in the face of actual or threatened tariffs on those imports. Others could potentially compete with imported goods if assured that those imports would face heavy tariffs; but they don’t know whether those tariffs are actually coming, or will endure. So everyone is sitting on piles of cash, waiting to see what an erratic president will do.
Of course, Trump isn’t the only problem here. Other countries have their own troubles — a European recession and a Chinese slowdown look quite likely — and some of these troubles are spilling back to the United States.
But even if Trump and company aren’t the source of all of our economic difficulties, you still want some assurance that they’ll deal effectively with problems as they arise. So what kind of contingency planning is the administration engaged in? What are officials considering doing if the economy does weaken substantially?
The answer, reportedly, is that there is no policy discussion at all, which isn’t surprising when you bear in mind the fact that basically everyone who knows anything about economics left the Trump administration months or years ago. The advisers who remain are busy with high-priority tasks like accusing The Wall Street Journal editorial page of being pro-Chinese.
No, the administration’s only plan if things go wrong seems to be to blame the Fed, whose chairman was selected by … Donald Trump. To be fair, it’s now clear that the Fed was wrong to raise short-term rates last year.
But it’s important to realize that the Fed’s mistake was, essentially, that it placed too much faith in Trumpist economic policies.
- If the tax cut had actually produced the promised boom,
- if the trade war hadn’t put a drag on growth,
we wouldn’t have an inverted yield curve; remember, the Fed didn’t cause the plunge in long-term rates, which is what inverted the curve. And the Trump boom wasn’t supposed to be so fragile that a small rise in rates would ruin it.
I might add that blaming the Fed looks to me like a dubious political strategy. How many voters even know what the Fed is or what it does?
Now, a word of caution: Bond markets are telling us that the smart money is gloomy about economic prospects, but the smart money can be wrong. In fact, it has been wrong in the recent past. Investors were clearly far too optimistic last fall, but they may be too pessimistic now.
But pessimistic they are. The bond market, which is the best indicator we have, is declaring that Trumponomics was a flop.
For decades, the freedom of monetary policymakers to make difficult decisions without having to worry about political blowback has proven indispensable to macroeconomic stability. But now, central bankers must ease monetary policies in response to populist mistakes for which they themselves will be blamed.CHICAGO – Central-bank independence is back in the news. In the United States, President Donald Trump has been berating the Federal Reserve for keeping interest rates too high, and has reportedly explored the possibility of forcing out Fed Chair Jerome Powell. In Turkey, President Recep Tayyip Erdoğan has fired the central-bank governor. The new governor is now pursuing sharp rate cuts. And these are hardly the only examples of populist governments setting their sights on central banks in recent months.
In theory, central-bank independence means that monetary policymakers have the freedom to make unpopular but necessary decisions, particularly when it comes to combating inflation and financial excesses, because they do not have to stand for election. When faced with such decisions, elected officials will always be tempted to adopt a softer response, regardless of the longer-term costs. To avoid this, they have handed over the task of intervening directly in monetary and financial matters to central bankers, who have the discretion to meet goals set by the political establishment however they choose.
This arrangement gives investors more confidence in a country’s monetary and financial stability, and they will reward it (and its political establishment) by accepting lower interest rates for its debt. In theory, the country thus will live happily ever after, with low inflation and financial-sector stability.
Having proved effective in many countries starting in the 1980s, central-bank independence became a mantra for policymakers in the 1990s. Central bankers were held in high esteem, and their utterances, though often elliptical or even incomprehensible, were treated with deep reverence. Fearing a recurrence of the high inflation of the early 1980s, politicians gave monetary policymakers wide leeway, and scarcely ever talked about their actions publicly.
But now, three developments seem to have shattered this entente in developed countries. The first development was the 2008 global financial crisis, which suggested that central banks had been asleep at the wheel. Although central bankers managed to create an even more powerful aura around themselves by marshaling a forceful response to the crisis, politicians have since come to resent sharing the stage with these unelected saviors.
Second, since the crisis, central banks have repeatedly fallen short of their inflation targets. While this may suggest that they could have done more to boost growth, in reality they don’t have the means to pursue much additional monetary easing, even using unconventional tools. Any hint of further easing seems to encourage financial risk-taking more than real investment. Central bankers have thus become hostages of the aura they helped to conjure. When the public believes that monetary policymakers have superpowers, politicians will ask why those powers aren’t being used to fulfill their mandates.
Third, in recent years many central banks changed their communication approach, shifting from Delphic utterances to a policy of full transparency. But since the crisis, many of their public forecasts of growth and inflation have missed the mark. That these might have been the best estimates at the time convinces no one. That they were wrong is all that matters. This has left them triply damned in the eyes of politicians: they
- failed to prevent the financial crisis and paid no price; they are
- failing now to meet their mandate; and they
- seem to know no more than the rest of us about the economy.
It is no surprise that populist leaders would be among the most incensed at central banks. Populists believe they have a mandate from “the people” to wrest control of institutions from the “elites,” and there is nothing more elite than pointy-headed PhD economists speaking in jargon and meeting periodically behind closed doors in places like Basel, Switzerland. For a populist leader who fears that a recession might derail his agenda and tarnish his own image of infallibility, the central bank is the perfect scapegoat.
Markets seem curiously benign in the face of these attacks. In the past, they would have reacted by pushing up interest rates. But investors seem to have concluded that the deflationary consequences of the policy uncertainty created by the unorthodox and unpredictable actions of populist administrations far outweigh any damage done to central bank independence. So they want central banks to respond as the populist leader desires, not to support their “awesome” policies, but to offset their adverse consequences.
A central bank’s mandate requires it to ease monetary policy when growth is flagging, even when the government’s own policies are the problem. Though the central bank is still autonomous, it effectively becomes a dependent follower. In such cases, it may even encourage the government to undertake riskier policies on the assumption that the central bank will bail out the economy as needed. Worse, populist leaders may mistakenly believe the central bank can do more to rescue the economy from their policy mistakes than it actually can deliver. Such misunderstandings could be deeply problematic for the economy.
Furthermore, central bankers are not immune to public attack. They know that an adverse image hurts central bank credibility as well as its ability to recruit and act in the future. Knowing that they are being set up to take the fall in case the economy falters, it would be only human for central bankers to buy extra insurance against that eventuality. In the past, the cost would have been higher inflation over the medium term; today, it is more likely that the cost will be more future financial instability. This possibility, of course, will tend to depress market interest rates further rather than elevating them.
What can central bankers do? Above all, they need to explain their role to the public and why it is about more than simply moving interest rates up or down on a whim. Powell has been transparent in his press conferences and speeches, as well as honest about central bankers’ own uncertainties regarding the economy. Shattering the mystique surrounding central banking could open it to attack in the short run, but will pay off in the long run. The sooner the public understands that central bankers are ordinary people doing a difficult job with limited tools under trying circumstances, the less it will expect monetary policy magically to correct elected politicians’ errors. Under current conditions, that may be the best form of independence central bankers can hope for.