By Arthur S. Guarino
As President, Donald Trump is attempting to fully control all aspects of the American economy: From trade policy with China, Mexico, and Canada, to taking credit for job growth in the United States, to growing Gross Domestic Product (GDP). But he is also creating havoc by his pronouncements on Tweeter in how the Federal Reserve Bank (the Fed) should do its job. Trump keeps urging lower interest rates and that the Fed has been more harm than good to the U.S. economy. What he fails to realize, or perhaps he actually does know, is that he is doing serious harm to not only the American economy in the short and long-term, but also to the independence of the Federal Reserve and its ability to do its job without any political interference.
The Federal Reserve Bank as an independent body
The Federal Reserve Bank was created in 1913 by Congress under the Federal Reserve Act in order to provide the United States with a secure, flexible, and stable financial system that will also set monetary policy. The United States had central banks previously, however they ultimately did not last long. But it took a financial crisis (the Panic of 1907) and subsequent economic depression to convince Congress to provide the financial capital for the creation of a central bank for the United States.
The role of a central bank is to determine, implement, and control a nation’s monetary policy. A central bank must be independent in its functioning as a financial entity that will have a deep and immediate impact on a nation’s economic well-being and long-term growth. A central bank’s independence is vital in that its decisions must not be influenced, controlled, ratified, approved or determined by the executive branch, namely the President of the United States. While the legislative branch, the Congress, has some oversight over the Federal Reserve since it has the power to coin money, it cannot dictate monetary policy.
The Federal Reserve has clear-cut objectives that are vital to ensure the nation’s economic and financial health. These include stimulating sustainable non-inflationary economic growth. The premise is that the GDP of the United States must grow in a stable manner over the long-term. The Fed must ensure the fact that the United States economy increases in a manner that is stable, predictable, and reliable in order to give Americans peace of mind and that financial markets avoid volatility.
The Fed’s other objective is keeping employment high and interest rates low in order to encourage long-term growth. The Fed is very concerned about Americans having jobs since this not only contributes to economic growth but also helps long-term national prosperity. The Fed also tries to keep interest rates as low as needed to help ensure long-term economic growth. There have been periods when the Fed raised interest rates substantially, such as in the early 1980’s, in order to combat severe bouts of inflation, control the money supply, and fulfill its role of enacting monetary policy for the good of the American economy. While the Fed has not been perfect in how and when it has done its job in enacting monetary policy, its overall track record has been commendable.
Trump’s interference is worrisome
As president, Donald Trump is attempting to control Fed monetary policy for political gain. Fed Chair Jerome Powell must walk a fine line in fulfilling the policy objectives of the Federal Reserve Bank while maintaining stability in the financial markets. Powell definitely realizes that any comment, remark, or pronouncement he makes, even in passing, can sway the financial markets one way or the other. Powell also knows that any decision the Fed Board of Governors makes will impact the lives of all Americans and more than likely influence other central banks around the world.
Trump’s recent Tweeter tirade is worrisome since he is attempting to tell the Fed its job for political purposes. Trump has his eye on the presidential election in 2020 and an increase in interest rates will make him look bad. Trump is demanding lower interest rates to the point where they will be at or near zero percent. Powell faces the problem that if interest rates hit zero percent in the next six months and there is recession in 2020, then the Fed has fewer if any weapons in its financial and economic arsenal to help prop up the American economy. If interest rates hit zero percent, and there is a severe or even moderate recession, the Fed may have to implement Quantitative Easing Part IV, or QE IV. The problem is that there are only so many Treasury and Government bonds available in the market place and there is no guarantee that such a policy will work right away or at all. During the Financial Crisis of 2008-09, QE I, II, and III had minimal real impact on the American economy.
Taking interest rates to zero percent in the relatively near future will place the Fed in a position with few choices outside of QE IV. The Fed may then need to consider the possibility of negative interest rates. The policy of negative interest rates has been implemented by central banks in Japan and Sweden with some success. But will the Fed use negative interest rates as a last resort and will the average American accept it as a stimulating economic and financial policy?
Donald Trump is urging the Fed to lower interest rates in order to achieve success with his trade war with China. As president, Trump has recently imposed 15 percent tariffs on Chinese goods coming into the United States as of September 1st. This replaces the 10 percent tariff Trump originally placed on goods imported from China. To make matters worse, goods and products that had a 25 percent tariff will be increased to 30 percent as of October 1st. Tariffs are an economic hit to American consumers and a possible way to delay any downturn is to lower interest rates. But the question is whether lowering interest rates does not work and the American economy still hits a recessionary period, whether severe or moderate. It seems as if President Trump and his team of economic advisors are trying to cover themselves in raising tariffs on China by encouraging the Fed to cut interest rates. But what if this tactic does not work? Will the nation’s chief executive seek another tax cut putting more money into the American economy and thereby see inflation take a nasty turn upwards? Or that a tax cut will only benefit 1 percent of Americans while the remaining 99 percent are mired in a recession?
Caught in the middle
Fed Chair Jerome Powell is caught in the middle between a president seeking re-election in 2020 and fulfilling Fed policy objectives. Powell is being threatened with being fired by Trump, but the question is whether Trump has the executive power to do so. Powell must block out Trump’s tweets and concentrate on assisting the American economy to stay on an even course as the financial markets are extremely volatile and that there may be signs of a recession coming in one to two years or perhaps sooner. Powell will have an extremely tough time for the foreseeable future and he must set monetary policy that will impact not only the world’s largest economy, but possibly the rest of the world while maintaining the Fed’s independence.
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