If you live in the US, it is hard to miss the ongoing tug of war between the White House and the US central bank, The Federal Reserve System (the Fed). The media is full of stories about the attempt by the current administration, particularly President Trump, to force the Fed to stop pursuing a tighter monetary policy in the coming months. The Fed raised interest rates four times in 2018 and were on course to raise rates at least twice in 2019. It now appears that the Fed has given up any plan to raise interest rate this year and there are speculations that it might even lower the rate.
Those who have not followed the drama, played out in other countries including the EU, may legitimately ask two questions: why was the Fed raising interest rates after keeping it low for many years?
Secondly, why did the Fed reverse its earlier plans to raise rates? Did the White House influence the supposedly independent Fed to take it easy and sit tight until the 2020 elections? For the readers to understand the subtle points of this complicated puzzle, where politics and economics interplay, a little background information is necessary.
The central banks, whether in the USA or in Bangladesh, have a very difficult balancing act to follow. The standard practice is for central banks to raise interest rates when inflationary pressures in the economy start to build up. On the other hand, if the GDP growth rate slows down or is sluggish, central banks typically lower interest rates in the expectation that cheaper credit will stimulate investment and GDP growth, and create jobs.
After pursuing an easy money policy since the last financial crisis in 2008, the Fed made the decision two years ago to start raising interest rates. And for a good reason. The US economy has been growing at a 3 to 4 percent range each quarter since President Trump won the elections in 2018, and the unemployment rate is at a historical low of 3.8 percent. There are fears that the tight labour market in the US might result in wage increases and stoke inflation. Since the 1980s, the Fed’s policy has been to keep the rate of inflation within a narrow band, and never let it exceed 2 percent. In 2016, the Fed announced that it will gradually raise interest rates over the next few years. The Fed raised rates three times in 2017 and four times in 2018. However, it made a sudden U-turn this year leaving the media and the so-called “political pundits” baffled.
It is not clear whether Trump threatened to fire Jerome Powell, the Chairman of the Federal Reserve, whom he appointed only last February. Some critics of the president have accused him of bullying Powell to do his bidding and coerced him to change the Fed’s monetary policy. It is true that last October, Trump had told reporters, “I think the Fed is making a mistake. They are so tight. I think the Fed has gone crazy.” According to a report cited by CNBC, President Trump threatened to fire Powell for raising interest rates which the news media characterized as “an unprecedented action by a president against the independent body that could undermine confidence in the U.S. financial system already under the strain of a vicious equity sell-off.”
Incidentally, the situation that the Fed faces itself in is not unique. First of all, central bankers everywhere are once again finding themselves in rough seas. There is uncertainty in the world economy due to the trade war and China’s economic woes. Secondly, the central bank is theoretically supposed to be independent of the government and its executive branch and politicians. But that’s more easily said than done.
Political leaders often promise easy loans at low interest rates before elections. Central bankers, on the other hand, have a different mandate. They also have to deal with loan defaults, inflationary pressures, and property boom, which are some of the “unintended consequences” of easy money policy. We have seen them in Bangladesh, China, Turkey, and all Western economies.
Coming back to the tug of war between Trump and Powell, readers may recall that the former came to power two years ago by promising to lower taxes to boost the economy. With the Republicans at the helm, the tax cuts were passed by both houses in 2017. However, there are still pockets of unemployment and industrial decay. Not everyone benefitted in the aftermath of the massive tax breaks that Trump lavished on the corporations and the wealthy 1 percent of the US population. For the average person, the guys who voted for Trump in 2016, the prospect of wage increases and well-paying manufacturing jobs has become a mirage. Now, with the primaries for 2020 presidential elections only a few months away, Trump is seeking another boost for the economy and is hoping that lower interest rates might come to rescue the Republicans.
Undoubtedly, if the Republicans could control monetary policy and had his party controlled the US Congress, it is a fair guess that Trump would have tried to print more money to push interest rates down. But the Republicans lost control of the House of Representatives in the last elections, and those in the Senate are pushing back at his attempts to control the Federal Reserve.
So, how much influence does the President have on monetary policy? Not a lot. Trump has since 2017 been broadcasting the benefits of lower interest rates. But, he realises that the interest rate policy lies within the purview of the Federal Reserve Board. He appointed a new Fed Chairman to replace Janet Yellen who was picked by the previous President, Barack Obama. Jerome Powell, being appointed by Trump, was expected to play his tune. But Powell is known to be an “inflation hawk”, a moniker reserved for those who would like to pursue aggressive policy inflation, and raise rates at the whiff of any inflationary pressure.
It is true that as soon as he became the Fed Chair, Powell came under pressure from the White House to shift gears and put its announced policy to raise the interest rate on hold. As I mentioned earlier, the Fed last year became concerned that the economy was overheating and inflationary pressures might be let loose.
But, latest data shows that inflation rates are low in the USA and EU. Core inflation has stayed in a fairly tight range over the past several years. “There isn’t enough inflation for the Federal Reserve to resume its gradual rate hikes,” according to Wall Street Journal (April 10, 2019).
Is the Fed going to lower interest rates which will undoubtedly please Trump? The answer is no. Because economic growth is looking stronger than expected, the possibility of rate cuts is remote. This sentiment also runs across the Atlantic where Mario Draghi, the outgoing President of European Central Bank said that inflation was not picking up as quickly as officials had expected.
Elsewhere, in the G20 countries inflation rates are very low, falling to its lowest level in eight years last June, according to OECD. The last time the monthly inflation rate was that low was in October 2009 where it was 1.7 percent but the economies were emerging from the global economic downturn.
So, the verdict is, while Trump tried to influence the Fed and put pressure on Powell to lower interest rates, it is now clear that Powell was not influenced by Trump. The Fed is holding off any further increases in light of the state of the US and global economies which show no signs of inflation.
Dr Abdullah Shibli is an economist and works in information technology. He is Senior Research Fellow, International Sustainable Development Institute (ISDI), a think-tank in Boston, USA.