Federal Reserve Chairman Jay Powell is a lifelong Republican. President Donald Trump appointed him to his job.
Trump also appointed three of the other four sitting members of the Fed's Board of Governors. In other words, it's a lot of Trump's Fed. And on the Fed board, there are two more vacancies that Trump can fill (there are seven in total). Republicans control the Senate and it is no longer possible for the minority party to veto presidential candidates.
Although, instead of being pleased with his team or modifying the team by adding two new members to the board, Trump spends his time publicly feuding with the Fed. In an interview with CNBC on June 1
Trump's desire for lower interest rates that would boost growth is not unusual for the president, but the voice public criticism of the Fed's chair is essentially unprecedented.
Trump has only escalated his rhetoric in recent days. Powell criticized Trump in a speech delivered at Jackson Hole, Wyoming on August 23, explaining that the Fed could not fully compensate for the economic damage caused by Trump's disruptive trade policy with China.
Trump stepped back, asking if Powell was a bigger enemy than China's authoritarian leader Xi Jinping.
…. My only question is who is our biggest enemy, Jay Powell or President Xi?
– Donald J. Trump (@realDonaldTrump) August 23, 2019
Trump's behavior, in his view, is inappropriate and incompetent, doing much to further disrupt the financial markets and little to achieve any of his goals. For his part, Bill Dudley, a former Fed official, went beyond the proper central banker behavior and suggested that it might be a good idea to try to sabotage Trump's re-election. The Fed mania is also the excuse for failures in his policies – Trump's ideas for trade are wrong, his tactics don't make sense and tax cuts don't work.
And yet, Trump's basic view that the Fed should cut interest rates more aggressively may be correct.
What the Federal Reserve does
The Fed has a fairly wide range of powers, but Trump's criticism is about his decisions on fixing short-term interest rates. The Central Bank Board of Governors is appointed by the president, but he makes decisions regardless of the White House and so far Trump has not tried to break the rule against firing Fed executives.
The Fed's Work is a Balancing Act: Lower It is assumed that rates will stimulate economic growth (making it easier for businesses to finance investments and for households to buy cars or large appliances). The problem with theory is that if you stimulate growth too much, you will get inflation – the desire to spend money will outstrip the economy's ability to produce things.
During the Great Recession, the Fed cut interest rates to zero and kept them there for years to help the US economy recover. The theory is that low interest rates increase both investment and consumption because it is cheaper to borrow and therefore less incentive to save.
In December 2015, the Fed raised rates for the first time since 2006, by 0.25 percentage points. The Fed then spent the next three years slowly but steadily raising rates, by a quarter percentage point each time, both in terms of Yellen and Powell.
Trump, as an unscrupulous opportunist, criticized the Fed for holding Obama's low rates too low, but now he has turned and is a defender of lower rates as president.
I am constantly critical of the Fed's willingness to raise rates for both Obama and Trump, but conventional wisdom has been on the Fed's side throughout this period. Then, on July 31, the Fed reversed course and cut a quarter percent rate against a broader set of fears about the global economy.
But that was not good enough for Trump, who kept a steady drum of tweets, calling for even lower percentages, arguing that it was not possible for America to compete with foreign countries issuing sovereign debt with negative nominal interest rates.
Our Federal Reserve cannot "mentally" keep up with competition – other countries. On the G-7 in France, all the other leaders were amused by how low the cost of interest was. Germany actually "gets paid" to borrow money – ZERO INTEREST PLUS! No Clue Fed!
– Donald J. Trump (@realDonaldTrump) August 28, 2019
In a typical corpse way, this confuses two issues that are, at best, weakly related. The European Central Bank's policy does not determine borrowing costs in Germany or the Netherlands. Northern Europe's low-cost sovereign debt reflects a combination of austerity budgets and poor overall growth prospects.
It is also not really true that this is competition. If the German economy grows faster, it will be good news for the United States, and if the US economy grows faster, it will be good news for Germany. The idea of the Fed as a fighter in battle is purely a product of Trump's own trade policy decisions against China and has nothing to do with the countries he met at the G7 conference.
The Fed and the Trade War
When competition is appropriate, Trump thinks the Fed needs to do more to help him win the trade war with China.
There are many complexities on this subject, including US tariffs, Chinese repayment measures, fluctuations in exchange rates, bailouts, and more. But trade disruptions generally hurt both economies. This creates a game of chicken. Ending the trade war would in itself be a "victory" for both parties. But whichever country can convince the other that it is more willing to get out, the pain may be advantageous in the negotiations.
In this dynamic, Trump's great advantage is that China is more exposed to trade, so the war hurts China more than it hurts the US.
The end of China is that their authoritarian political system makes it easier for Jinping to get out of the lie about what is happening and at least give the country more unity in decision-making. By contrast, Trump has only limited powers to change US public policy without Congressional approval, and House Democrats have limited incentive to continue with Trump's efforts to "win" against China.
Here comes the Fed. Trump has appointed most of the board to the Fed, but he does not control decision-making. He wants the Fed to strengthen the economy by aggressively cutting interest rates to give it an edge with Xi.
Powell's point is that he cannot simply do the harm of trade disruptions, he can only partially mitigate them. Trump is angry about this, and at some level his anger doesn't make much sense. If he really wants to boost the economy, all Trump has to do is make a deal to save people with China and get things back to normal. Nevertheless, it is in fact true that monetary policy is not sufficiently growth oriented.
The Fed raised interest rates too early
All the Trump nonsense aside, here's the reality: If you go back to 2015, when the Fed started raising interest rates, inflation was well below the Fed's 2 percent target rate. More broadly, if the Fed successfully targets 2 percent, inflation will be above 2 percent about as often as below 2 percent. In fact, inflation is systematically below the target.
This low inflation, by itself, is good. Everyone likes it when prices are low. But it is a sign that the Fed was more aggressive than it should have been in raising interest rates and slower than it should have been in recognizing mistakes and changing course.
It must be said that while Trump's criticisms of this front are accurate, he is hardly consistent. The rate hikes began when Obama was president, and at the time Trump said the rates were too low. Given the tightness of Trump's victory in the election, it is possible (or even likely) that if the Fed did not make that mistake, the slightly faster economic growth in 2016 that would result from lower rates, would push Hillary Clinton across the line. So personally, Trump is not the victim. The victims are hundreds of thousands of people who could get a job faster if the Fed were more cautious about these percentage increases.
And it seems that Trump has no idea how to actually solve this problem.
Trump has to make good appointments to the Fed
If Trump was good at being president, he would take advantage of the two unfilled vacancies aboard the Fed for policy change.
He could accomplish this by asking his employees to name for him the names of four or five highly-skilled economists who have sought lower interest over the years. You would like to find people who have taken a principled position in this direction, dating back to Trump winning the election. This is the minority point of view among economists, but it is not very rare and would not be a challenge to create names.
Trump may want to further insist that the election is a solid Republican, which would significantly narrow the scope, but would hardly reduce it to zero. By the coincidence that Trump is reading this, I would suggest looking at Carl Smith and David Beckworth.
Such electors would be confirmed by the Senate and then their presence would push monetary policy in the direction Trump wants.
What Trump does, however, is the floating names of various hacks or people like Judy Shelton who have no attempt to advocate for monetary growth policy until it becomes clear that Trump wants it. His first two kills along those lines, Stephen Moore and Herman Kane, fell into flames, and his third, Shelton, seems to be struggling to some extent.
But Trump does not seem to understand that this failure to properly select the nominees is at the root of his problem, which causes him to instead focus on Powell's baptism on Twitter as his preferred policy change approach. This may in theory work (though compromising the Fed's institutional independence would be a problem), but at some level it seems least likely to trigger a fire, prompting members of the Fed's board to believe they must defend the Fed's independence by not doing what Trump wants. If such a rebate happens, it will be a small tragedy – Trump doesn't understand the issues at all, but his general preferences are right – but it just shows that having a president who has no idea what he's doing is not a great idea overall.