How to Gauge the Fed’s Reaction to Trump’s Tweet

(Bloomberg Opinion) -- Judging from commentary in markets late last week, an additional factor now features in the calculus of some Fed watchers as they look forward to this week’s two-day Federal Open Market Committee meeting: how policy makers will respond to President Donald Trump’s tweets suggesting that the central bank refrain from raising interest rates and risk “taking away our big competitive edge.”

Opinions vary a great deal, and for understandable reasons. Some feel that the Federal Reserve policy makers will go out of their way to ignore the pressure, while others believe they will have no choice but to be influenced by the president’s remarks. Within this latter group, there is even disagreement on how this influence will play out. With that comes a higher risk of a policy mistake at a complicated time for central banking around the world.

Appreciating this, the Fed is likely to decide on policies and behave — both internally and externally — as if Trump’s remarks were never made. Yet the Fed may have a difficult time avoiding misinterpretations of what it ends up doing and why.

The issue of political challenges for central banks is a longstanding one. History is full of cases of both overt and behind-the-scene politically motivated demands on these institutions to be more stimulative. A brief survey of them points to three basic things that traders and investors may wish to keep in mind as they think about how the Fed will — and should — respond this week.

No. 1. The influence of politics on central banks is not a new issue.

The Fed has had a variable relationship with U.S. political leaders. To this day, Arthur Burns, Fed chairman from 1970 to 1978, is remembered for succumbing to pressure from President Richard Nixon to relax monetary policy in the run up to the 1972 election. This pressure was imposed both directly in face-to-face meetings (including Nixon urging Burns to “think of goosing it … late summer and fall of this year and next year”) and indirectly through newspaper leaks and threats to structurally increase the White House’s control of the institution. It followed earlier (and unsuccessful) attempts by President Lyndon Johnson to persuade Fed Chairman Willian McChesney Martin to ease policy — including one meeting in which Johnson is said to have complained that “My boys are dying in Vietnam, and you won’t print the money I need.” President George H.W. Bush, in the middle of a hotly contested re-election bid in 1992, also tried to not-so-subtly influence the Fed, saying “I’d like to see another lowering of interest rates. … I can understand people worrying about inflation. But I don’t think that’s the big problem now.”

The Fed isn’t the only central bank dealing with political issues these days. Politicians haven’t been shy in expressing strong opinions about the policies of the European Central Bank and the Bank of England.

Of course, the most egregious cases of persistent political influence on central banks come in emerging markets, and the outcome has typically included some mix of inflation, domestic and external financial turmoil, and a destabilizing run on reserves. In the last few months it has been playing out most visibly for markets in countries such as Argentina and Turkey, where concerns about political interference have led to considerable instability in exchange rates and risk spreads. And then there is Venezuela, where heavy government interference in the central bank’s operations has helped fuel an inflation rate that is heading to 1 million percent, according to the latest International Monetary Fund assessment.

No. 2. Political pressure tends to put central banks in a lose-lose position.

No central banker wishes to wake up to news of increased political pressure.

Resistance would risk antagonizing politicians and exposing the central bank to bigger and more enduring structural damage. But agreeing to political demands that have no economic justification would lead to central banks abrogating their policy objectives. And whatever they end up doing, communication is always very tricky — exposing the institution to major reputational harm and other risks.

No. 3. That’s why central banks prize their structural autonomy so much, as do economists.

Because of all this, many central banks have sought and secured varying degrees of autonomy. In many cases, this involves the freedom to decide on the tools to use to meet objectives that, although specified by politicians, are not easy to change. (This is what economists call instrument independence but not goal independence.) To make sure that structure does the heavy lifting, central-bank autonomy is often established by legislation.

The desirability of central-bank autonomy is one of the few things that the vast majority of economists readily agree on. It is seen to have played a key role in breaking inflationary spirals, including in the 1970s, that disrupted many advanced and emerging economies. And when just less than 10 years ago the global economy was facing the real and present danger of falling into a devastating multiyear depression, autonomy ensured that central banks had the leeway to deploy unconventional policies. That is something for which we should all be grateful.

With this as background, expect the Fed to respond — very carefully — in the following way to Trump’s tweets:

• In both the run-up and aftermath of this week’s FOMC meetings, officials will do their utmost to avoid any public commentary on the issue.

• They will work hard to sidestep the remarks during their policy deliberations, which will continue to be driven by pure economic, financial and market considerations.

• The policy decisions they iterate to, including what to signal about the timing and number of hikes in the remainder of this year, are unlikely to be reflect in any material way President Trump’s expressed views on monetary policy.

This, however, will not make the Fed’s public communication task any easier. Indeed, whatever the Fed decides to do, it will be blamed by someone somewhere to have fallen under the influence of the president in one of two ways: succumbing to his pressures if it decides on Wednesday not to signal high likelihood of a rate hike in September; and, should it indeed send such a signal, being accused by some to have gone too hawkish in order to show that it prizes its independence.

There are good reasons why so many have warned politicians away from commenting on central banks. We will likely see some of the underlying reasoning play out again this week, even though the Fed will end up behaving exactly as it would have had Trump not commented on its policies.

To contact the editor responsible for this story: James Greiff at jgreiff@bloomberg.net

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

Mohamed A. El-Erian is a Bloomberg Opinion columnist. He is the chief economic adviser at Allianz SE, the parent company of Pimco, where he served as CEO and co-CIO. His books include “The Only Game in Town” and “When Markets Collide.”

©2018 Bloomberg L.P.