Dear readers,
I wrote back in February that Trump had chosen the better of the two Kevins to lead the Federal Reserve. After some idiotic comments from National Economic Council head Kevin Hassett last week, I continue to feel good about that assessment.
At a conference in Georgetown, Hassett blamed members of the Federal Open Market Committee for the recent spike in long-term interest rates. He complained that some policymakers at the Fed — specifically, “a lot of the people who weren't appointed by President Trump” — are bent on further interest rate hikes. He considers those hikes unwarranted because core PCE inflation has hit the Fed’s 2% target on average over the last three months; therefore, he concludes, rates are currently high enough. Of course, the Fed looks at many data points over various time horizons, and a lot of policy observers are less sanguine about inflation than Hassett. Fed governor Michael Barr, for example, argues that core PCE ran above target for 18 of the last 20 months, and that inflation hasn’t abated for long enough to say the inflation outlook is mild. But Hassett attributes disagreement from the likes of Barr, a Biden appointee, to this being “an unusually partisan Fed” that acts to help Democrats and hurt Trump. He attributes the rise in long-term rates to a worry among investors that the Fed will take rates to somewhere like 6% and hold them there for political reasons — a course of policy action that, if expected, would tend to push up yields on long-term bonds right now.
Hassett sees evidence of this partisan meddling in Jay Powell’s and Barr’s unusual decisions not to resign from their Federal Reserve Board seats when their time in Fed leadership expired. While Hassett is correct that this is unusual, he implies they stayed on the board so they can visit political harm on the president, and he even says Warsh has “work to do to restore Fed independence” — an Orwellian claim that the Fed lacks independence because it is somehow under the political control of Democrats.
I do think Trump is the reason Powell and Barr chose to stay on the board, rather than doing the usual thing and going off to make a bunch of money in the private sector or enjoying retirement, but Hassett is wrong about the why. One reason Fed Board members have resigned their terms early is that, for the last five decades, there has been broad consensus in Washington about monetary policy. During this period, four different Fed chairs were nominated and renominated by presidents of both political parties (Volcker, Greenspan, Bernanke and Powell). Board members could resign and expect to be replaced by someone with a fairly similar monetary policy outlook and a commitment to the Fed’s dual mandate on inflation and employment, rather than monetary policy according to the president’s political desires.
That consensus has broken down, and so has that custom. President Trump does not want an independent Fed; he wants a pliable central bank that will set interest rates wherever he wants. He has periodically proposed wildly inappropriate nominees for Fed Board seats — such as Steve Moore, Herman Cain and Judy Shelton — because he believed they would give him the low interest rates he wanted regardless of the economic environment. The most important thing sitting members of the Fed Board can do to protect the Fed’s independence and ensure it continues to focus on its dual mandate is to stay in their seats, so that’s what they’ve been doing.1
Hassett’s argument that long-serving Fed members ought to step down is one we often hear about why a president’s cabinet nominees ought to be shown deference by the Senate that gets to confirm them: He ought to be able to put his team in place so he can pursue the policy agenda voters chose. But the Fed is explicitly designed so the president can’t do that. Fed Board members serve very long 14-year terms spanning multiple administrations. It is supposed to be difficult for a new administration to quickly steer the Fed in a new policy direction. Powell and Barr staying in place so the president can’t remake the board with hacks is a defense of Fed independence, not a threat to it.
There is one amusing aspect of Hassett’s characterization of Warsh as hampered by a “partisan” Federal Open Market Committee. After the FOMC voted unanimously to raise interest rates at its meeting this month, President Trump claimed he had spoken with Warsh before the meeting and told him it was fine to go ahead and vote for a hike — after all, the hostile board was going to make Warsh do it anyway. If Trump (and Hassett) blame the whole FOMC for higher rates, that insulates Warsh from political blowback for doing the opposite of what Trump wants; and if Trump claims he signed off on the rate vote, that saves him from looking like he can’t control his own Fed appointee (how embarrassing!). But it is far from clear that Warsh wishes he could have blocked the rate hike — or that he will want to block future hikes that the FOMC is likely to approve in the coming months.
Warsh has been insistently Cheshire Cat-like about the likely future path of monetary policy. He gives evasive answers most of the time, and he’s open about why: he thinks the Fed has recently talked too much and locked itself into inappropriate policy courses. While I am not totally sold on Warsh’s approach here, it is true that we are no longer at the zero lower bound of interest rates, and so some of the circumstances that led the Fed to rely so much in recent years on robust communication about future actions no longer apply. But Warsh has spoken clearly and consistently about one other thing: the Fed will get inflation down to the 2% level and keep it there. If he intends to keep that promise, he will have to raise interest rates under certain circumstances, such as continued elevated inflation. Indeed, a reluctance to talk means that he will have to take sharper interest rate actions than a chattier Fed chair might.
I am not saying I believe there will be a rate hike at the FOMC’s October meeting. There is disagreement among FOMC members about how concerning the inflation outlook remains,2 and some benign inflation data this month has strengthened the argument of those on the committee, such as New York Fed President John Williams, who says there is “no need for urgency” in hiking rates again. But as Michael Barr noted in one of those hawkish speeches that so annoyed Hassett, the few recent months of modest core PCE inflation were proceeded by more than a year of above-target inflation, and it is not clear that the inflation outlook has stabilized sustainably. Even the relatively dovish FOMC members are open to raising rates again soon; Williams, for example, says one more rate hike might be needed before the end of the year. If more bothersome economic data comes over the next few months, I not only think the Fed is likely to hike again; I think Warsh is likely to think that’s a good idea.
It is true that we have lost something institutionally at the Fed. The old system, where central bank independence was implemented primarily though an informal agreement to pursue a common monetary policy across Republican and Democratic administrations, was better than this new system, where that independence has to be protected formally by preventing the president from getting extra opportunities to fill seats on the Fed Board. I’m hopeful that the next Republican president will see that the war on the Fed created no political gains for President Trump, and that the old consensus can be resurrected.
Very seriously,
Josh
As Victoria Guida noted back in the spring, some Fed observers have worried that, if Trump managed to strong-arm his way to a friendly majority on the Federal Reserve Board, that majority might fire presidents of the regional Federal Reserve Banks in order to reshape the Federal Open Market Committee. Five of the 12 seats on the FOMC are reserved for regional Fed bank presidents, and the U.S. president has no direct role in choosing those. This is a worst-case scenario but can’t be put past an administration that has repeatedly tried to come up with legally aggressive maneuvers to replace members of the FRB. The NEC head getting up on a stage to accuse some of the regional bank presidents of being Democratic partisans doesn’t make me less worried the Trump team would try it.
Incidentally, one problem with Hassett’s claim that a “partisan” FOMC is pushing higher rates is that one of the hawkish members who dissented in favor of raising rates earlier this year, Minneapolis Fed President Neel Kashkari, was literally the Republican nominee for governor of California in 2014.