Preserve The Federal Reserve’s Independence
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President Trump and his chief economic adviser, Larry Kudlow, have publicly questioned the Federal Reserve’s recent rate hikes. These assertions break with decades of custom and, if they continue, would be at odds with the goals shared by the president and the Fed.
We have come to expect an independent central bank, but the value of that arrangement has not always been clear. When the Federal Reserve was first chartered, the Secretary of the Treasury and the Comptroller of the Currency had ex officio seats on the Federal Reserve Board. During World War II, the Fed supported the United States’ war effort by fixing low interest rates in order to minimize the government’s cost of debt. However, persistently easy money supply led to substantial postwar inflation. In 1951, the Fed asserted its full control of monetary policy with the Treasury-Fed Accord.
Even then, the executive branch would sometimes intervene. Fearing a recession, President Nixon counseled his Fed chair to hold rates low to keep the market stimulated, which led to problematic inflation throughout the 1970s. It took the willful leadership of Fed Chairman Paul Volcker (and a painful recession) to get inflation under control. A central bank that can be swayed is one that can do damage to the economy in the long run.
The timing of the current administration’s remarks is questionable. Two years of steady rate hikes have not yet impaired the economy. Interest rates remain below the long-term averages we saw before the financial crisis.
One possible motivation may be that the U.S. Treasury feels the most immediate pain from higher rates. The budget deficit is growing, and a majority of federal government debt is in short-duration instruments which need to be refinanced continually. But it is the Treasury’s choice to rely on short-term borrowings; a strategy focused on longer-date issuance would have left the budget better protected against the inevitable normalization of monetary policy.
We do not expect comments from the White House to sway the steady, well-telegraphed rate course of the Fed. The administration might be better advised to focus on matters more directly under its control, the sound handling of which would make the Fed’s job a little easier.