Thursday, November 10, 2016

Political Pressures on the Fed and the Trump Presidency

On Monday evening, Charles Weise gave a seminar at Haverford on "Political Pressures on Monetary Policy during the U.S. Great Inflation," a paper he published in 2012. In the paper, he details how Congress and the Presidents (especially Nixon) pressured the Fed, both directly and indirectly, to pursue loose monetary policy that contributed to the Great Inflation in the 1970s.

The paper highlights the fact that although the Fed is nominally independent, Congress and the President can influence the Fed's actions by threatening to restrict the Fed's independence. This is not necessarily a bad thing. One way to try to make the Fed accountable to the public is to make the Fed accountable to publicly-elected officials. This can be achieved by several (imperfect) means-- hearings and testimonies and other transparency requirements, the appointment process, and (threatened) legislation. Problems arise when the interests of the elected officials are not in line with the interests of the electorate. In the 1970s, for example, Nixon's interest in maintaining low unemployment at the cost of high and rising inflation was for the sake of political gain and neglected adverse long-run consequences. Problems can also arise when the interests of elected officials are in line with those of the public, but elected officials' understanding of monetary policy is severely flawed.

It was coincidental that this talk was the evening before Election Day. The candidates' views on the Fed got less attention than many other issues and aspects of the campaign, but they did come up from time to time. Donald Trump, for example, claimed that "We are in a very big, ugly bubble...The Fed  is more political than Hillary Clinton.”

Now, a big question is what Trump's election will mean for the future of the Fed. Beyond the relatively minor issue of whether this unexpected election result will cause the Fed to postpone its next rate hike, the larger issues have to do with legislation and future appointments.

In the Great Recession and ever since, we have seen many calls and proposals for more accountability for the Fed from both sides of the political spectrum. Most of these have at least some merit, even if they are misguided to varying degrees. They stem from a recognition that the Fed is powerful, and that its actions affect the distribution of resources and the health of the global economy. But the types of legislation that Trump seems likely to support would drastically restrict the Fed's independence and discretion-- he has even mentioned a desire to return to the gold standard.

Moreover, no legislation designed to promote accountability can be effective without choosing monetary policymakers that are well-qualified technocrats to skillfully implement policy. Janet Yellen's term as Fed Chair ends in 2018, and Trump has suggested that he will not reappoint her. This would represent a departure from the pattern established by Obama's reappointment of Ben Bernanke, who was originally appointed by George W. Bush. Obama's reappointment of Bernanke signalled that the Fed Chair was a technocratic position, not a partisan one. Yellen, like Bernanke, is well-credentialed for her post. Vice Chair Stanley Fischer's term also ends in 2018, and there are two other open seats on the Board of Governors. Monetary policy is complex enough that even a well-intentioned policymaker without substantial knowledge and skill could spell trouble. A neither well-intentioned nor highly skilled policymaker would almost guarantee disaster.

Finally, monetary policy will interact with other economic policies. Lower long-run growth means lower natural interest rates. This means that we are already uncomfortably close to the zero lower bound, and almost certain to hit it again with the next recession. Severely restrictive trade and immigration policy will even further reduce the economy's capacity for growth, compounding this problem.