Deficit Hawks Are Officially Extinct

(Bloomberg Opinion) -- There is no party of fiscal responsibility in the U.S. But there is the Fed. Will it matter?

Financial market turbulence in the fourth quarter of last year tightened financial conditions and led the Federal Reserve to rethink plans to increase interest rates multiple times in 2019. Strengthening that posture have been forecasts for relatively poor economic growth in the first quarter of 2019, with estimates currently around 1 percent for real gross domestic product growth. Add in inflation data that continues to come in around 2 percent rather than significantly above the Fed’s target, and an unemployment rate a touch higher than the Fed anticipated a few months ago.

With rates falling since the Fed’s meeting last Wednesday, investors are now pricing in higher odds of an interest rate cut in 2019 rather than any hikes. My Bloomberg Opinion colleague Tim Duy has argued that by now it’s clear that the Fed’s interest rate hike in December was a policy mistake. He says that with the yield curve slightly inverted, officials should cut rates immediately, which would represent "cheap insurance" given that we haven’t seen a breakout in inflation. The Chicago Federal Reserve president raised the prospect of interest rate cuts in comments on Monday.

So the Fed switching from a hawkish to a neutral bias, a yield curve inversion, and chatter of the possibility of a rate cut in 2019 — all point to a tendency toward caution. But the Fed may be losing sway, and the larger political culture has turned much more cavalier than cautious.

President Donald Trump has flouted the norm of central bank independence by publicly berating Federal Reserve Chairman Jerome Powell for increasing interest rates following the passage of Republicans’ Tax Cuts and Jobs Act, complaining that the hike is diminishing the Trump administration’s fiscal stimulus.

Now the president has nominated loyalist Stephen Moore to a Federal Reserve Board of Governors seat. Trump appears to be giving up on the Fed as an independent body and plans to appoint allies to the Fed from here on. Moore’s confirmation would create a precedent for the Fed to become politicized like the Supreme Court.

There is little doubt about the direction in which Trump would like to nudge the Fed. The administration has modeled disregard for federal budget deficits. The Tax Cuts and Jobs Act increased the budget deficit by around $1.5 trillion over a decade, continuing a trend of Republicans passing budget-busting tax cuts when they’re in power though this time the advocates made fewer pretenses about the cuts fueling economic growth that would generate tax revenue.

Democrats are happy to shed the restraints of fiscal prudence as well. Consider the shift in the Democratic Party since the midterm election in November. While it’s unclear how much support these policies have in the party as a whole  and no less a luminary than former President Barack Obama warns his party about the price tag influential freshman members like Alexandria Ocasio-Cortez and multiple Democratic presidential candidates have come out in support of ambitious programs like the Green New Deal and Medicare for All. Their paeans to such big government initiatives don’t include much discussion of their cost or impact on the federal budget deficit. From Trump to Ocasio-Cortez and back to Republicans, it’s come full circle as a bipartisan mind-set: Even one Republican senator, Lamar Alexander, recently proposed “a new Manhattan Project for clean energy.”

The American political system is incredibly resistant to change, and has multiple veto points across layers of government. That being said, at the moment, structurally bigger budget deficits, a Green New Deal or the equivalent, Medicare for All, a federal jobs guarantee, and a politicized Federal Reserve are all possible — and the main resistance to them is simply inertia.

As we’ve seen over the past couple years, political norms are not binding. There’s nothing magical about an independent central bank or a 2 percent inflation target or, certainly, a balanced budget.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Conor Sen is a Bloomberg Opinion columnist. He is a portfolio manager for New River Investments in Atlanta and has been a contributor to the Atlantic and Business Insider.

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