The Federal Reserve (Fed) shouldn’t cut interest rates, because that only enables President Donald Trump to pursue a mistaken trade war, according to Bill Dudley, Ex-NY Fed President. Dudley urged that Fed officials should state explicitly that the central bank won’t “bail out an administration that keeps making bad choices on trade policy, making it abundantly clear that Trump will own the consequences of his actions.” So when the Fed bailed out Bush, bad policy decisions weren’t made?
Dudley served as vice chairman of the Federal Open Market Committee from 2009 through 2018. He starting during the height of the Great Recession and wrote that he understands the Fed’s desire to say out of politics and to respond to the economic conditions as they exist, but the Fed will do more long-term damage to the economy if the Fed gives Trump what he wants with lower rates. So the Fed wants to stay out of politics, but in fact, are not – since the Fed seems they know better than Trump on trade policy.
Bankers are not surprisingly agreed with the Fed. They are talking about an adverse feedback loop (see inset chart), where more tariffs, leads to a weaker economy. That then leads to Fed easing which strengthens the economy. Rinse and repeat the process. It is a strategy – a political one. The idea behind the strategy is to create a more level playing field in terms of tariffs – something the middle-class factory worker has been complaining about for decades. But the Fed seems to know what is better for the middle-class, or are they doing what they have always done – cater to their stakeholders? The point here is that this is the president’s decisions, not the Fed’s.
This idea that the Fed is supposed to be independent and stick to policy-making as economic indicators lead them, has been sort of a “prime directive” of what a central banker is supposed to do. Is this now changing? Trump too has been guilty of trying to politicize rate-making policy. It seems a week does not go by that Trump tries to “jaw bone” the Fed into lower rates. Obviously, this is political, as Trump wants a good economy going into the 2020 presidential elections.
Many presidents in the past have also been criticized for the same strategy of politicizing the Fed (here is one example from way back during the Nixon area). Here is yet another example from Turkey, when their president Erdogan fires their central bank chief – highly problematic for their economy. In the case of Turkey, the rest of the world didn’t really care too much to watch Turkey falter, but the U.S. having a global reach is another matter.
News Forecasters is not taking sides in this debate. However, we can say that politicizing rate-making policy is kryptonite for the markets. For markets that have gotten used to central banking independence, it is breaking the trust – though one perhaps that should be broken. News Forecasters believes that this seems to be the path we are on.
A major revamp, Brenton Woods style is in the cards at the Fed in the next 5 to 10 years. These comments made by Dudley will ensure this, not lessen this. The danger is, that in general, this politicization of a monetary system tends to lead to bad or wrong policy, and can lead to a disaster for the economy.