First, Trump’s attack was on the Fed itself rather than on its independence per se. He did report that he was “not happy” with forthcoming interest rate increases, and at first I too thought he was seeking to forestall them. But upon reflection, I decided that Trump is playing a subtler game: laying the groundwork for blaming the Fed if anything goes wrong with the U.S. economy.
In essence, Trump wants a fall guy. He may be secretly afraid that his “trade war” and general political volatility — or just plain bad luck — will damage the U.S. economy. If that happens, Trump will need a political target to absorb the criticism. With midterm elections around the corner, he doesn’t want to point the finger at Congress. Hillary Clinton can no longer serve as a plausible target. So the Fed is the convenient scapegoat. The last thing he wants is for the Fed to do exactly as he says, because then he would have no one to blame but himself. He did stress, “I’m letting them do what they feel is best.”
If Trump really wanted lower interest rates, he could have nominated extreme doves to the Fed board. But in fact he has selected a mix of moderates and sometimes even (mild) inflation hawks. That’s another sign Trump is playing a blame-shifting game, rather than trying to undermine the Fed’s independence or to achieve eternal low interest rates.
You might even argue that Trump is trying to increase the Fed’s independence, though at the cost of its credibility. “Don’t associate these losers with me” is the message.
The other problem with interpreting Trump’s tweets as weakening the Fed’s independence is that the Fed never has been fully independent in the first place. For one, the president appoints Fed governors, subject to Senate approval. For another, Congress can revoke or alter the charter of the Fed at any time.
Within these constraints, the Fed does make its own decisions. But that is not the same as saying it is free to make any decision it wants. During a downturn, for instance, the Fed could aim for 4 percent inflation, to boost aggregate demand. Its clear reluctance to do so can be explained not by macroeconomic theory but by public opinion and, ultimately, congressional pressure. In an age of relative wage stagnation, higher inflation rates would mean real wage cuts for many voters.
The result? A Fed that does not respond strongly enough to crises.
To better see the role of politics here, compare the U.S. Fed to the New Zealand Reserve Bank, perhaps the least independent central bank among developed nations. Since 1990, New Zealand has had a system where the Reserve Bank and the minister of finance agree on a range for the rate of price inflation. In other words, the government takes basic responsibility for what the Reserve Bank will do. If the Reserve Bank fails in this regard, there is an obligation to explain what went wrong and why.
On paper, this is very different from the procedures of the U.S. Federal Reserve. Yet the Reserve Bank and the minister of finance, acting together, have chosen inflation rates between 0 and 3 percent, with 2 percent as a desired midpoint. U.S. rates of price inflation have been in the 0 to 2 percent range over the same period. And both the U.S. and New Zealand have been falling somewhat short of a 2 percent target as of late. In other words, broadly similar results end up being channeled through some very different institutional procedures.
All this said, Trump’s Twitter outburst is likely to be harmful to monetary policy looking forward. Ideally, the Fed would have more latitude to defy public opinion and opt for higher inflation rates when the next economic crisis so dictates. Attacking the Fed won’t help in that regard. What would, in contrast, is a president — and a Congress — that indicate in advance that they will have the Fed’s back in an economic or financial emergency.
Trump’s tweets didn’t have a major impact on the market this time. The real danger is more long-term, during the next crisis, when the concept of Fed independence is taken to mean that the Fed is truly standing alone.
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.
Tyler Cowen is a Bloomberg Opinion columnist. He is a professor of economics at George Mason University and writes for the blog Marginal Revolution. His books include “The Complacent Class: The Self-Defeating Quest for the American Dream.”
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