Keating: Drama at the Federal Reserve
by Maryann O. Keating, Ph.D.
The Trump-Powell feud over the interest rate is Shakespearean. Who knew that monetary policy could be so riveting? At this point, Kevin Warsh has emerged from a list of pretenders as President Trump’s nominee for the next Chairman of the Federal Reserve (Fed), replacing Jerome Powell.
The big question on everyone’s mind: If Warsh is appointed, does this mean that Trump will now have a direct hand in setting monetary policy? Probably not. The Federal Reserve is designed to operate independently of political pressure, and this independence is unlikely to disappear. However, the way monetary policy is implemented could shift, and the Fed may indeed be in need of a serious overhaul.
Consider how monetary policy is generally presented in Econ 101. The basic idea is straightforward: When prices are rising too fast, the Fed raises interest rates to cool the economy down. When growth stalls and jobs dry up, it lowers rates to encourage borrowing and spending. In practice, the timing of these moves has always been one of the most politically charged decisions in Washington — and there is a longstanding debate among economists about whether interest rates are even the correct target.
The Fed is legally tasked with two goals: keeping prices stable and keeping unemployment low. Yet over the years, it has ventured into other responsibilities — some of them deeply political. Under administrations of both parties, the Fed has been accused of keeping interest rates artificially low in order to make it cheaper for the federal government to service its enormous debt. It has also bought and sold foreign currencies to influence the value of the dollar in ways that serve broader diplomatic goals. These are real problems that demand attention — but they are best addressed elsewhere, not by Fed monetary policy.
So, what interest rate exactly are Trump and Powell fighting over? When people talk about “the interest rate,” they are really referring to a kind of benchmark representing both short- and long-term lending and borrowing rates. The thousands of different interest rates operating in the economy tend to be synchronized and move together over time. The president’s concern is with the overall target rate that the Fed tries to actively manage. It seeks to do this through buying and selling treasury bonds, adjusting the interest it pays banks on their reserves, and controlling the size of its own balance sheet.
Trump’s position is clear; he prefers lower interest rates. Thia is somewhat surprising because wealthy individuals (and retirees) typically benefit from higher interest rates, which deliver better returns on their savings and investments. However, Trump, like most career businesspeople, tends to be concerned with the availability of credit and the cost of credit consistent with low interest rates.
Affordable credit is certainly one of the engines of economic growth and job creation. If pushing for a lower rate is the administration’s priority, the natural follow-up question is an important one: Does this indicate that the fight against inflation is being put on the back burner? Apparently, those Fed officials — including Warsh himself — willing to pursue a lower target rate believe that it is consistent with price stability.
No Fed official would necessarily argue against attempting to increase or decrease credit in a genuine emergency. So why are they suggesting now, in the absence of a crisis, that current rates may simply be too high? Think of it this way: Imagine a party where someone keeps removing the punch bowl and d’oeuvres the moment the music starts getting good. A criticism leveled at Fed economists for decades is that time and again they have argued for higher interest rates and tightening the money supply just as the economy was finally picking up momentum.
There is a legitimate case to be made that some of the Fed’s current tools are unnecessarily choking the flow of credit for all industries, with the housing market being one of the most visible examples. When affordable borrowing leads to more investment, jobs are created and more goods and services are produced. Increases in the supply of all goods and services actually put downward pressure on prices. This is not a guarantee but may be worth a try.
Whoever ends up leading the Federal Reserve next — whether Kevin Warsh or someone else — will inherit a position in which the stakes are high for all Americans. The person at the helm will need sharp economic instincts and the courage to act on them. We wish the new Fed Chair well and we will be watching.
Maryann O. Keating, Ph.D., a resident of South Bend and an adjunct scholar of the Indiana Policy Review Foundation, is co-author of “Microeconomics for Public Managers,” Wiley/Blackwell.
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