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.

Presidential Candidates and Fed Accountability

In an interview with Fortune, Donald Trump gave his views on  Federal Reserve Chair Janet Yellen, who will come up for reappointment in 2018. "I don’t want to comment on reappointment, but I would be more inclined to put other people in," he remarked, despite his opinion that Yellen "has done a serviceable job."

A change in the political party in power does not always result in a new Fed chair. Yellen's predecessor, Ben Bernanke, was first appointed by President George W. Bush and later reappointed by President Obama. Obama remarked, upon reappointing Bernanke in 2009, that "Ben approached a financial system on the verge of collapse with calm and wisdom; with bold action and out-of-the-box thinking that has helped put the brakes on our economic freefall."

Time reported in 2009 that "The Fed chairman is often described as the second most powerful U.S. official; the main check on him is the first most powerful official's power not to reappoint him. That power won't be used this year, and it's easy to see why. But someday, a President may have to use it..." I have written before that Fed accountability is a two-way street requiring diligence on the part of both the Fed and Congress. But the President also plays a role in checking the Fed's power. Just how far should a (prospective) President go?

Recently, Narayana Kocherlakota, who was President of the Federal Reserve Bank of Minneapolis from 2009 through 2015, has been urging Presidential candidates to address their views on the Fed. He proposes five questions we should ask the candidates, including whether they would seek a chair that would want to change the Fed's 2% inflation target, whether they would want the next chair to change the Fed's approach to its full employment mandate, whether they would want the chair to agree with using a Taylor-type rule for monetary policy, and whether they would want the chair to take an interventionist approach in a future crisis.

Good to see Mr. Trump talking about mon. pol. - more Pres. cands need to talk about this issue: https://t.co/1kMKThHmAS

— NRKocherlakota (@kocherlakota009) April 20, 2016

Kocherlakota tweeted, "Good to see Mr. Trump talking about mon. pol. - more Pres. cands need to talk about this issue." This was not Trump's first discussion of the Fed. Trump previously claimed that "Janet Yellen for political reasons is keeping interest rates so low that the next guy or person who takes over as president could have a real problem."

In Trump's Fortune interview, he continued to express some qualms with low interest rates, namely: "the problem with low interest rates is that it’s unfair that people who’ve saved every penny, paid off mortgages, and everything they were supposed to do and they were going to retire with their beautiful nest egg and now they’re getting one-eighth of 1%." However, he also pointed to an upside of low rates, noting that he would like to take advantage of low interest rates to refinance the debt and increase infrastructure and military spending.

Interestingly, neither of Trump's takes on the Fed's interest rate policy are directly related to the Fed's Congressional mandate. He does not evaluate the Fed's success in achieving either price stability or full employment. Rather, he is concerned with the distributional and fiscal implications of low interest rates--areas in which the Fed chair is traditionally reluctant to tread.

The other candidate who has said most about the Fed is Bernie Sanders, who wrote an op-ed about the Fed in the New York Times in December. Sanders' remarks focus mainly on Fed governance and financial regulation, though he also comments on the Fed's interest rate policy:

The recent decision by the Fed to raise interest rates is the latest example of the rigged economic system. Big bankers and their supporters in Congress have been telling us for years that runaway inflation is just around the corner. They have been dead wrong each time. Raising interest rates now is a disaster for small business owners who need loans to hire more workers and Americans who need more jobs and higher wages. As a rule, the Fed should not raise interest rates until unemployment is lower than 4 percent. Raising rates must be done only as a last resort — not to fight phantom inflation.

On Friday, I took my students in my Federal Reserve class at Haverford on a field trip to DC, where we got to meet with Ben Bernanke at the Brookings Institute. I asked Bernanke whether he thought that the presidential candidates should talk about monetary policy and the (re)appointment of the Fed Chair. He agreed with Kocherlakota that candidates should talk about what they would like to see in a Fed Chair, but said that he does not think it's a good idea to politicize individual interest rate decisions, emphasizing that the Fed does not have goal independence, but does have instrument independence. In other words, Congress has given the Fed a monetary policy mandate—full employment and price stability—but does not specify what the Fed needs to do to try to achieve those goals.

Anyone who wants to is welcome to evaluate the Fed on how successfully they are achieving that mandate. Anyone who wants to is also welcome to evaluate the merits of the mandate itself. Different people will come to different evaluations depending on their own beliefs and preferences. But neither of these two evaluations requires an audit of monetary policy by the Government Accountability Office, as both Sanders and Trump have advocated.

Anyone who is dissatisfied with the mandate itself can go through the usual channels of political change in a democracy and pressure Congress to change the mandate. Congress, by design, is susceptible to such pressure: they need votes. Presidential candidates are in a good position to draw public attention to the Fed's mandate and urge change if they believe it is necessary. Sanders, for example, could propose redefining the Fed's full employment mandate to mean unemployment below 4 percent. I'm not quite sure what kind of mandate Trump would support. It is also fair game for any member of the public to evaluate the Fed on how successfully they are achieving their mandate. But Congress does not (or at least, should not) tell the Fed how to set interest rates to achieve its mandate, and Presidential candidates shouldn't either.