The Fed Needs to Start Playing a Smarter Political Game

(Bloomberg Opinion) -- There is a direct line between the U.S. Federal Reserve’s December interest-rate increase and last week’s announcement that Stephen Moore is set to be nominated to an open seat on the central bank’s Board of Governors. The Fed needs to start playing a smarter political game sooner rather than later. The risk to its independence has probably never been higher.

The speed at which the Fed has reversed direction from December suggests policy makers realize a mistake was made three months ago. They could have taken a cue from financial markets and the persistently low inflation environment to take a pass at that meeting. The next meeting was just six weeks away and was “live” in the sense that a press conference was already scheduled. 

Instead, it appears the desire to push policy rates into what they believed to be neutral territory clouded their collective judgement. Were other factors at play? Did the central bank hold its ground on a rate hike at least in part to push back against President Donald Trump’s repeated attacks on Fed Chairman Jerome Powell? The Fed denies that political considerations enter into their decision-making process. Its position is that the Fed makes policy independent of politics.

The Fed might need to start rethinking its notion of independence and how it relates to politics. Trump’s appointments to the Fed — Powell, Randal Quarles, Richard Clarida and Michelle Bowman — have all been qualified candidates for the job. The same is true for those candidates — Marvin Goodfriend and Nellie Liang — who have been less successful at navigating the Senate confirmation process. None of these candidates could be said to be outside of the mainstream.

That all changed when Trump announced he intended to nominate Moore to the Board of Governors. The commentariat was less than impressed. Up until last week, the idea that someone like Moore could be offered a top spot at the Fed was unthinkable. The Fed has been viewed as an entity that would be immune to the fate of other departments where political considerations trumped qualifications when it came to appointments. That is no longer the case. We must now view the Fed as a target for political change just as other positions that require presidential nominations.

How did we get here? It’s not exactly rocket science. Trump realized that if he wanted the type of monetary policy he desired, he needed to pick people that would produce that policy. Maybe he thought Powell was such a person. If so, he was wrong.

Even if he doesn’t make it through vetting and the Senate, the attempt to elevate Moore to the Fed is a significant development. It underlines something about the Fed’s independence that has been forgotten, which is that it’s more fragile than often believed. Fed independence requires the adherence of all parties to the convention of independence and the ability of the Fed to meet its mandate effectively.

Trump already tossed aside conventions with his tirades against rate increased, while the Fed’s ill-fated December hike calls into question its ability to meet its mandates. Powell admitted last week that the Fed has not met its symmetric inflation target in any meaningful way. Moreover, the recent yield curve inversion raises the risk that a recession is on the horizon. The Fed politically can’t afford having tightened into a recession absent an actual inflationary threat. The result of such an outcome will be a future filled with additional Moores.

The cost of the December rate hike now looks fairly high, economically and politically. This new dynamic puts the Fed in an uncomfortable position. Powell would have been better served by losing the battle but winning the war by appearing to give Trump the win and passing on the rate boost. Trump may have been appeased and felt like the appointment process was working just fine. Instead, the Fed is backtracking and Trump has dramatically lowered the bar on acceptable appointees to the Fed. It’s time for the Fed to start playing a different game.

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

Tim Duy is a professor of practice and senior director of the Oregon Economic Forum at the University of Oregon and the author of Tim Duy's Fed Watch.

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