Is Politics Getting to the Fed?

Robert Barro in a new PS piece:

It is no secret that Trump regards the stock market’s performance as an indicator of his own performance. But it has been surprising to see the Fed join the rate-cutting bandwagon. In early 2019, it indicated that it would pause its rate increases, and now it is signaling a sequence of rate cuts in the near future. I, for one, cannot see how the Fed’s sudden reversal fits with the coherent monetary policy that it maintained from 1984 until the financial crisis.

Nonetheless, Powell has tried to justify the move toward rate cuts as consistent with that prior policy. First, he points out, rightly in my view, that inflation has remained tame. Then, he argues that the economy’s prospects may be weaker than low unemployment and recent strong real GDP growth suggest. There may be something to that argument, given Trump’s  and worsening prospects for global growth. Even so, it does not follow that rates should be cut before actual economic weakness appears – I do not know of convincing evidence that the Fed should “get ahead” of a slowing real economy.

The danger, then, is that the Fed will be tempted to cut rates as a result of external pressure, on the assumption that it can always rationalize cuts by pointing to variables that seemed to augur a growth slowdown sometime in the future. It is telling that Powell has not mentioned (at least that I have heard) the fact that the nominal and real federal funds rates remain well below long-term normal values. (This deviation is even more apparent for interest rates in some other advanced countries, such as Germany and Japan.)

The desire to restore normalcy should still be putting upward pressure on rates, just as it did during the period of rate increases between December 2016 and December 2018. Indeed, it was Bernanke’s earlier failure to initiate the normalization process that made things more difficult than necessary for Yellen and Powell.

My view is that the shift in 2019 away from normalization is primarily due to the intense opposition to further rate increases last December, when the loudest objections came, notably, from stock-market analysts and the Trump administration.

The entire point of  is to establish a credible monetary policy by insulating the relevant decision-makers from such influence. That is what we  from the early 1980s, when Fed Chair Paul Volcker hiked the federal funds rate up to the level necessary to choke off inflation. The big difference, of course, is that President Ronald Reagan supported Volcker, whereas Trump is Powell’s chief antagonist.

Powell’s challenge, then, is to maintain Volckerian discipline and independence in the face of growing political pressure. At the moment, his prospects for success are not great.

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