Trump and Powell Actually Agree About Monetary Policy

(Bloomberg Opinion) -- Although President Donald Trump and Federal Reserve Chairman Jerome Powell have been at odds on Twitter and in official statements, the two share remarkably similar views about the economy and what needs to be done to improve it. The trick for the chairman will be to carry out monetary policy without appearing to cave to the president — and the president, meanwhile, needs to give the chairman some room to work.

The official responses from both parties following their meeting this week suggest that they might finally realize this. Just after the meeting Trump offered a critical but notably restrained tweet (only later did he note that he “protested” high interest rates). Powell’s statement, terse even by the tight-lipped standards of the Fed, simply reiterated that he will be guided by its mandate of stable prices and maximum employment.

Both responses underscore the need for Powell to avoid being seen as overly influenced by the president.

Trump has made no secret of his disdain for the economic consensus. He rejects arguments for free trade, openly scorns global institutions and prefers to promote U.S. interests in foreign countries rather than free markets and the rule of law. He has also driven economists to distraction by challenging the two pillars of central banking: independence from political influence and a strong bias toward lower inflation.

These tenets developed in the wake of the high inflation of the 1970s, which led to political efforts to pressure central banks into lowering interest rates, even in the face of rising inflation. But they are currently being rethought.

An increasing number of economists are questioning the prevailing models of the economy’s full potential. And now Powell himself is cautioning against overreliance on contemporaneous models of economic output.

Typically the Fed has used such models to predict when inflation was imminent, then raised interest rates in response. But in his last press conference Powell went so far as to rule out the possibility of raising interest rates until inflation was actually increasing, effectively throwing out any dependence on inflation-forecasting models. Powell has also said repeatedly that low inflation, not high inflation, is the greater danger.

That view puts him at odds with the received wisdom — and on the side of Trump. The problem is that while Powell wants to throw out the low-inflation-bias portion of the modern consensus, he is keen on keeping the political-independence part.

So even as Powell effectively agrees with the president, he cannot afford to be seen as bowing to Trump’s pressure. That means that Trump’s excoriations against the Fed actually serve to undermine a natural ally. If Trump can restrain himself (admittedly a big if) and Powell can make an effective economic (rather than political) case for a softer line on inflation, then both men will get the monetary policy they want — and that America needs.

To contact the editor responsible for this story: Michael Newman at mnewman43@bloomberg.net

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

Karl W. Smith is a former assistant professor of economics at the University of North Carolina's school of government and founder of the blog Modeled Behavior.

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