You are here
The Fed shouldn't enable Donald Trump
US PRESIDENT Donald Trump's trade war with China keeps undermining the confidence of businesses and consumers, worsening the economic outlook.
This manufactured disaster in the making presents the Federal Reserve with a dilemma: Should it mitigate the damage by providing offsetting stimulus, or refuse to play along?
If the ultimate goal is a healthy economy, the Fed should seriously consider the latter approach.
The Fed's monetary policymakers typically take what happens outside their realm as a given, and then make the adjustments needed to pursue their goals of stable prices and maximum employment.
They place little weight on how their actions will affect decisions in other areas, such as government spending or trade policy.
The Fed, for example, would not hold back on interest rate cuts to compel Congress to provide fiscal stimulus instead. Staying above the political fray helps the central bank maintain its independence.
So, according to conventional wisdom, if Mr Trump's trade war with China hurts the US economic outlook, the Fed should respond by adjusting monetary policy accordingly - in this case by cutting interest rates.
But what if the Fed's accommodation encourages the president to escalate the trade war further, increasing the risk of a recession? The central bank's efforts to cushion the blow might not be merely ineffectual. They might actually make things worse.
Fed chairman Jerome Powell has hinted that he is aware of the problem. At the central bank's annual conference in Jackson Hole last week, he noted that monetary policy cannot "provide a settled rulebook for international trade". I see this as a veiled reference to the trade war, and a warning that the Fed's tools are not well suited to mitigate the damage.
Yet the Fed could go much further. Officials could state explicitly that the central bank will not bail out an administration that keeps making bad choices on trade policy, making it abundantly clear that Mr Trump will own the consequences of his actions.
Such a harder line could benefit the Fed and the economy in three ways. First, it would discourage further escalation of the trade war, by increasing the costs to the Trump administration.
Second, it would re-assert the Fed's independence by distancing it from the administration's policies.
Third, it would conserve much-needed ammunition, allowing the Fed to avoid further interest rate cuts at a time when rates are already very low by historical standards.
I understand and support Fed officials' desire to remain apolitical. But Mr Trump's ongoing attacks on Mr Powell and on the institution have made that untenable.
Central bank officials face a choice: enable the Trump administration to continue down a disastrous path of trade war escalation, or send a clear signal that if the administration does so, the president, not the Fed, will bear the risks - including the risk of losing the next election.
There is even an argument that the election itself falls within the Fed's purview. After all, Mr Trump's re-election arguably presents a threat to the US and global economy, to the Fed's independence and its ability to achieve its employment and inflation objectives.
If the goal of monetary policy is to achieve the best long-term economic outcome, then Fed officials should consider how their decisions will affect the political outcome in 2020.
The writer is a senior research scholar at Princeton University's Center for Economic Policy Studies. He served as president of the Federal Reserve Bank of New York from 2009 to 2018, and as vice-chairman of the Federal Open Market Committee. He was previously chief US economist at Goldman Sachs.