NEW HAVEN – Blinded by a surging stock market and a 50-year low in the unemployment rate, few dare to challenge the wisdom of US economic policy. Instant gratification has compromised the rigor of objective and disciplined analysis. Big mistake. The toxic combination of ill-timed fiscal stimulus, aggressive imposition of tariffs, and unprecedented attacks on the Federal Reserve demands a far more critical assessment of Trumponomics.
Politicians and pundits can always be counted on to spin the policy debate. For US President Donald Trump and his supporters, the art of the spin has been taken to a new level. Apparently, it doesn’t matter that federal deficits have been enlarged by an estimated $1.5 trillion over the next decade, or that government debt will reach a post-World War II record of 92% of GDP by 2029. The tax cuts driving these worrying trends are rationalized as what it takes to “Make America Great Again.”
Nor are tariffs viewed as taxes on consumers or impediments to global supply-chain efficiencies; instead, they are portrayed as “weaponized” negotiating levers to force trading partners to change their treatment of the United States. And attacks on the Fed’s independence are seen not as threats to the central bank’s dual mandate to maximize employment and ensure price stability, but rather as the president’s exercise of his prerogative to use the bully pulpit as he – and he alone – sees fit.
There are three basic flaws with Trump’s approach to economic policy.
- First, there is the disconnect between intent and impact. The political spin maintains that large corporate tax cuts boost US competitiveness. But that doesn’t mean deficits and debt don’t matter. Notwithstanding the hollow promises of supply-side economics, revenue-neutral fiscal initiatives that shifted the tax burden from one segment of the economy to another would have come much closer to real reform than the reduction of the overall revenue trajectory has. Moreover, the enactment of fiscal stimulus in late 2017, when the unemployment rate was then at a cyclical low of 4.1% (headed toward the current 3.6%), added froth to markets and the economy when it was least needed and foreclosed the option of additional stimulus should growth falter.
Similarly, Trump’s tariffs fly in the face of one of the twentieth century’s greatest policy blunders – the Smoot-Hawley Tariff of 1930, which sparked a 60% plunge in global trade by 1932. With foreign trade currently accounting for 28% of GDP, versus 11% in 1929, the US, as a debtor country today, is far more vulnerable to trade-related disruptions than it was as a net creditor back then.
Ignoring the cascading stream of direct and retaliatory taxes on consumers and businesses that stem from a tariff war, Trump extols the virtues of tariffs as “a beautiful thing.” That is painfully reminiscent of the 1928 Republican Party platform, which couched tariffs as “a fundamental and essential principle of the economic life of this nation … and essential for the continued prosperity of the country.” Trump ignores the lessons of the 1930s at great peril.
The same can be said of Trump’s recent Fed bashing. The political independence of central banking is widely regarded as the singular breakthrough needed to achieve price stability following the Great Inflation of the 1970s. In the US, passage of the so-called Humphrey-Hawkins Act of 1978 gave then-Fed Chairman Paul Volcker the political cover to squeeze double-digit inflation out of the system through a wrenching monetary tightening. Had Volcker lacked the freedom to act, he would have been constrained by elected leaders’ political calculus – precisely what Trump is doing in trying to dictate policy to current Fed Chair Jerome Powell.
2) The second critical flaw in Trump’s economic-policy package is its failure to appreciate the links between budget deficits, tariffs, and monetary policy. As the late Martin Feldstein long stressed, to the extent that budget deficits put downward pressure on already depressed domestic saving, larger trade deficits become the means to fill the void with surplus foreign saving. Denial of these linkages conveniently allows the US to blame China for self-inflicted trade deficits.
But with tariffs likely to divert trade and supply chains from low-cost Chinese producers to higher-cost alternatives, US consumers will be hit with the functional equivalent of tax hikes, raising the risk of higher inflation. The latter possibility, though seemingly remote today, could have important consequences for US monetary policy – provided, of course, the Fed has the political independence to act.
Finally, there are always the lags to keep in mind in assessing the impact of policy. While low interest rates temper short-term pressures on debt-service costs as budget deficits rise, there is no guarantee that such a trend will persist over the longer term, especially with the already-elevated federal debt overhang projected to increase by about 14 percentage points of GDP over the next ten years. Similarly, the disruptive effects of tariffs and shifts in monetary policy take about 12-18 months to be fully evident. So, rather than bask in today’s financial-market euphoria, politicians and investors should be thinking more about the state of the economy in late 2020 – a timeframe that happens to coincide with the upcoming presidential election cycle – in assessing how current policies are likely to play out.
There is nothing remarkable about a US president’s penchant for political spin. What is glaringly different this time is the lack of any pushback from those who know better. The National Economic Council, established in the early 1990s as an “honest broker” in the executive branch to convene and coordinate debate on key policy issues, is now basically dysfunctional. The NEC’s current head, Larry Kudlow, a long-standing advocate of free trade, is squirming to defend Trump’s tariffs and Fed bashing. The Republican Party, long a champion of trade liberalization, is equally complicit. Trump’s vindictive bluster has steamrolled economic-policy deliberations – ignoring the lessons of history, rejecting the analytics of modern economics, and undermining the institutional integrity of the policymaking process. Policy blunders of epic proportion have become the rule, not the exception. It won’t be nearly as easy to spin the looming consequences.
President Trump reportedly chose Stephen Moore for one of the vacancies at the Federal Reserve Board after reading a Wall Street Journal op-ed Moore wrote attacking the Fed. The piece, co-authored with Louis Woodhill, made two central claims: (1) we’re experiencing deflation, and (2) the way to address it is to follow a rule adopted by Paul Volcker in the 1980s.
Slight problem though: Both of those claims are flat-out false. There is no deflation, and Volcker never created the imaginary “rule” Moore is now attributing to him. I know, because I asked Volcker — as Moore once suggested I do.
Deflation, for those unfamiliar, means prices are falling. There are three major measures of price changes: the consumer price index, the personal consumption expenditures (PCE) price index, and the “core” PCE price index (which excludes energy and food, which can be volatile). All three show modest but positive year-over-year price increases.
.. Moore and Woodhill explain this away by saying that in fact we shouldn’t be looking at overall price changes — instead we should be looking at just a small subset of prices, specifically commodities. Commodities refer to goods that are interchangeable with one another, such as metals, oil, soybeans, wheat, etc.
Now, there’s a reason why when people talk about inflation or deflation they usually focus on the overall index rather than some cherry-picked subset of products. Some products see prices go up (doctor visits); others see them go down (TVs); what we want to know is the big-picture trend. Sure, it’s possible that changes in commodity prices might eventually flow through to elsewhere in the economy. It’s also possible that commodities have weird, anomalous price changes driven by sudden shocks — a crop failure, say, or discovery of gold, or an oil embargo. These supply or demand shocks tell us little about whether there is too much money chasing too few goods, which is really what the Fed is trying to track.
Moore historically has had trouble distinguishing whether price changes in commodities are driven by monetary policy (that is, the Fed allowing too much or too little money to slosh around) or market-specific shocks. For instance, when I’ve appeared with him on CNN before, he has cited as evidence of “deflation” the fact that U.S. soybean prices have fallen. And hey, soybean prices are down! But as everyone in America except apparently Moore is aware, soybean prices have fallen primarily because China stopped buying U.S. soybeans in retaliation for Trump’s trade war, not because of changes in the money supply.
Nonetheless, Moore claimed in this op-ed, as well as in that CNN appearance, that his confused understanding of inflation and Fed policy was endorsed by none other than the godfather of sound Fed policy: former Fed chairman Paul Volcker.
.. On CNN, Moore said that we should follow the “Volcker Rule,” which he claimed was a rule Volcker set when he was chair in the 1980s that required linking interest rates according to movements in commodity prices. That is not actually anything close to what the Volcker Rule is about. It’s actually a regulation that prohibits banks from conducting certain investment activities with their own accounts, and has nothing to do with commodity prices or interest rates. I figured he’d misspoken, or gotten confused (this was around 7 a.m., after all), and moved on.
I was then surprised to see that Moore resuscitated this claim again in his recent Journal op-ed — you know, the one that earned him his Fed nomination. This time he didn’t foolishly refer to it the “Volcker Rule”; he said it was Volcker’s “commodity-price rule”:
The solution is obvious. The Fed should stabilize the value of the dollar by adopting the commodity-price rule used successfully by former Fed chief Paul Volcker. To break the crippling inflation of the 1970s, Mr. Volcker linked Fed monetary policy to real-time changes in commodity prices. When commodity prices rose, Mr. Volcker saw inflation coming and increased interest rates. When commodities fell in price, he lowered rates.
.. On Monday, I wrote to Moore to ask him where I could find more information about this rule, explaining that I had consulted Fed transcripts and other documents to no avail. He replied to say that Arthur Laffer, his longtime business partner and frequent co-author, had written “two very famous pieces” for the Wall Street Journal about the subject in the 1980s.
He eventually sent me one Journal op-ed from 1982, by Laffer and Charles Kadlec. It does not in fact say that Volcker adopted a price rule; rather, it says that Laffer and Kadlec speculated that such a relationship might be able to explain interest rate movements over the previous four months, and proposed how to test their theory. The headline, ending in a telltale question mark: “Has the Fed Already Put Itself on a Price Rule?”
Turns out Cato Institute senior fellow and economic historian George Selgin was also looking into Moore’s claim, and dug up another Laffer essay from this era. In this one (in Reason), Laffer explicitly says Volcker replied to that 1982 Journal op-ed to explain to Laffer why the Fed was not targeting commodity prices. Selgin also found a paper by another Fed official — written just after Volcker stepped down, in 1987 — arguing (apparently unsuccessfully) that the Fed should start adopting a rule such as the one Moore describes. Which, of course, implies that the Fed had not had any such rule when Volcker was in charge.
.. When I first, shall we say, expressed skepticism about Moore’s claim in that CNN debate, he suggested I get things from the horse’s mouth.
MOORE: Do you know what the Volcker Rule was? You know how he killed inflation? He followed commodity prices. Every time commodity prices went up, he — he raised interest rates, and every time —
RAMPELL: That’s not what the Volcker Rule is.
MOORE: Yes, it was. That’s what he did, and that’s how we conquered inflation, and that’s why —
RAMPELL: Google the Volcker Rule, people. That’s not what the Volcker Rule is.
MOORE: Yes, it was. Ask him. Ask him.
So I figured, why not ask Volcker? I sent an inquiry through his book publicist, who passed it along to Volcker’s assistant. The assistant replied: “I showed this to Mr. Volcker and he says that he does not remember ever establishing a commodity-price rule.”
There you have it. Trump has nominated to the world’s most powerful central bank a guy who has trouble telling whether prices are going up or down, and struggles to remember how the most famous Fed chair in history successfully stamped out inflation. But hey, Republican senators still seem keen on him because “the establishment” keeps pointing out how inept he is.
Federal Reserve leaders for the past quarter-century have made decisions about interest rates without being pressured by the president.
President Trump has broken that streak, calling the central bank “crazy” for raising rates and more than once saying the Fed is damaging the economy. That has prompted Fed Chairman Jerome Powell to update playbook rules for dealing with a president annoyed by America’s central bank.
Rule 1: Speak not of Mr. Trump.
Rule 2: When provoked, don’t engage.
Rule 3: Make allies outside the Oval Office.
Rule 4: Talk about the economy, not politics.
.. Mr. Trump blamed the Fed for October’s stock market selloff, calling the central bank “out of control.” The president told The Wall Street Journal Oct. 23 that Mr. Powell seemed to enjoy raising rates.
Not since the 1990s has a president leaned so hard on the Fed chief and never so publicly. On Monday, Mr. Trump told the Journal: “I think the Fed right now is a much bigger problem than China.”
.. The Fed’s benchmark interest rate is now in a range between 2% and 2.25%, well below long-run averages. The central bank is expected to raise rates by a quarter-percentage-point at its Dec. 18-19 meeting.
Mr. Powell says he is raising rates to return them to a more normal setting and avoid the type of boom-and-bust economy that ended in past recessions.
.. Mr. Trump has said he doesn’t plan on firing Mr. Powell, and it isn’t clear he could. The Federal Reserve Act states a Fed governor can only be removed for cause, a high bar that courts and legal scholars have interpreted to mean malfeasance or neglect.
.. The Fed’s credibility could suffer
- if investors believe its commitment to guard against inflation has been compromised by politics, or
- if Mr. Trump’s attacks sour the public’s view of the central bank.
“At some point, it becomes very damaging to the institution to be perceived as not acting in the best interest of America,” former Fed Chairwoman Janet Yellen said in an interview.
.. Mr. Powell has told others that he knows the president’s criticism could make his life unpleasant, but that he wouldn’t respond to political pressure. People close to Mr. Powell said he understood that history would judge him on policy decisions made over his four-year term.
- President Lyndon B. Johnson once summoned Fed Chairman William McChesney Martin to his Texas ranch to berate him for raising interest rates, saying it was despicable, according to Mr. Martin’s account.
- One low point for the central bank came when President Richard Nixon privately pressured Fed Chairman Arthur Burns to keep rates low before the 1972 election, according to Oval Office recordings. Mr. Burns kept rates low and inflation accelerated.
.. Shortly after President Reagan’s inauguration, a White House staffer asked Fed Chairman Paul Volcker if he wanted to host the new president at the Fed. Mr. Volcker declined, but replied he would be happy to meet the president anywhere else. They settled on the Treasury Department as a neutral ground.
Top Reagan administration officials frequently criticized Mr. Volcker, who presided over rate increases that triggered recessions in 1980 and 1981. But President Reagan refrained. “He just never did it,” Mr. Volcker said in an interview last year.
.. President George H.W. Bush’s Treasury Secretary Nicholas Brady cut off regular breakfasts with Fed Chairman Alan Greenspan to show his disapproval of tight-money policies in 1992. Mr. Brady stopped inviting Mr. Greenspan to dinner parties and golf dates at Augusta National.
“Our decisions can’t be reversed by the administration,” Mr. Powell said earlier this month in Dallas. “Of course, Congress can do whatever it wants.”
.. Messrs. Coons and Sen. Jeff Flake (R., Ariz.) later decided to send Mr. Trump a letter telling him to lay off the Fed.
“You appear to be telling the Fed what to do with interest rates, which we believe is unconstructive and dangerous,” the senators wrote the president.
.. In his new memoir, Mr. Volcker described how White House chief of staff James A. Baker III, with President Reagan watching silently, ordered the Fed chairman not to raise interest rates before the 1984 election.
Mr. Volcker, who wasn’t planning to lift rates anyway, didn’t tell colleagues or lawmakers about the episode. Mr. Baker has said he didn’t recall that.
Our current debt may be manageable at a time of unprecedentedly low interest rates. But if we let our debt grow, and interest rates normalize, the interest burden alone would choke our budget and squeeze out other essential spending. There would be no room for the infrastructure programs and the defense rebuilding that today have wide support.
.. Instead, we’d be dependent on foreign investors’ acquiring most of our debt — making the government dependent on the “kindness of strangers” who may not be so kind as the I.O.U.s mount up.
.. Our health care systems can be made more efficient, with better approaches toward cost control. Since health care represents 70 percent of the growth of our major entitlement programs over the next 30 years, bending the cost curve is essential to the long-term well-being of our economy.
.. Fair and responsible reforms will take years to implement. And businesses and individuals will need time to adjust.
.. Delaying action now will make the needed changes only more painful and difficult later on, while also increasing the risk of financial crisis before the reforms are even made. That is why the real debate should begin immediately.
.. the Clinton campaign said in a statement. “Like Trump’s campaign, this speech gave us a troubling view as to what a Trump State of the Union would sound like — rambling, unfocused, full of conspiracy theories and attacks on the media, and lacking in any real answers for American families.”
.. Mr. Trump has a long history of threatening and occasionally following though on litigation, and it was possible he was simply trying to intimidate more women from coming forward. Another accuser — she would be the 11th — was scheduled to appear later Saturday at a news conference with Gloria Allred