Trump May Get His Rocket If the Fed Juices Growth, But It Won’t Last

(Bloomberg) -- The U.S. economy might indeed take off like a rocket if the Federal Reserve acquiesces to President Donald Trump’s demand that it open the monetary spigots. The trouble is that such a radical shift would increase the risk of crash-landing later.

Economists said a huge dollop of cheaper credit could spur growth in the short term by boosting spending by consumers and companies. But it’s also likely to revive what until now has been quiescent inflation, eventually forcing the Fed to slam on the brakes in response.

“You may get a short boost in growth mainly because of a shot in the arm to demand,’’ said Nariman Behravesh, chief economist at IHS Markit. “But it’s not going to do anything for the long-term growth rate of the economy and therefore it will almost assuredly be inflationary.’’

Trump on Tuesday called on the Fed to cut interest rates by a full percentage point and resume buying bonds, saying on Twitter that the economy would soar “like a rocket” in response.

The president’s tweets came just hours after Fed Chairman Jerome Powell and his colleagues began a two-day policy meeting at which they are widely expected to hold interest rates steady. An announcement of their decision is due at 2 p.m. on Wednesday, followed by a Powell press conference 30 minutes later.

While previous attacks by Trump on the Fed have at times roiled markets, traders remained relatively unrattled by the latest comments, focusing instead on the possible details of the Fed’s decision.

Deutsche Bank Securities chief economist Peter Hooper said the central bank’s Federal Open Market Committee would spook financial markets if it followed Trump’s advice.

Investors would conclude either that the FOMC thought that the economy was in terrible shape or that it had effectively ceded monetary policy making to the administration, he said.

“Now that’s a frightening thought,’’ said Hooper, a 26-year veteran of the central bank.

Trump, who is up for re-election in 2020, complained that the Fed was holding back growth while China was “adding great stimulus to its economy’’ and keeping interest rates low.

The White House is ramping up pressure to reach a trade deal with China in the next two weeks, warning that the U.S. is prepared to walk away from the negotiations.

Powell has repeatedly said the Fed will not be swayed by political pressure and will do what it thinks is best for the economy.

Stiffer Backs

Former Fed Vice Chairman Alan Blinder said Trump’s overt pressure on the politically-independent central bank could prove counter-productive.

“At the margin, it might stiffen the back of the FOMC so as not to appear to be caving in to the White House,’’ said Blinder, who is now an economics professor at Princeton University.

The last time the Fed reduced interest rates, in 2008, the economy was mired in the worst recession since the Great Depression. A cut now would come as unemployment is near a five-decade low and wage growth is picking up.

Inflation though remains muted, stuck below the Fed’s 2 percent target -- a point that Trump and his acolytes have honed in on in their attacks on the central bank.

The administration argues that its tax cuts and deregulatory actions are boosting the supply side of the economy, allowing it to grow faster without generating higher inflation. Many economists, though, are skeptical that the president’s policies will generate anything like the long-term gains he’s claiming for them.

Inflection Point

Moody’s Analytics Inc. chief economist Mark Zandi said it’s only a matter of time before price pressures build in response to the taut jobs market.

“We’re at an inflection point,’’ he said. “As unit labor costs increase, businesses will be under pressure to raise prices.’’

A rate cut now would increase the risk of the economy over-heating and “just set us up’’ for an eventual recession, he said.

Whether that would occur before the November 2020 presidential election though is unclear.

In urging the central bank to loosen credit, “the president is speaking more about his desire for strong growth going into his election’’ than setting out an analytical framework for the central bank to follow, another former Fed vice chairman, Donald Kohn, told CNBC television on Tuesday.

To contact the reporter on this story: Rich Miller in Washington at rmiller28@bloomberg.net

To contact the editors responsible for this story: Scott Lanman at slanman@bloomberg.net, Alister Bull

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