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When the White House and the Fed Collide…
I am not a superforecaster. And you really don’t need to be one to have anticipated a potential conflict brewing between monetary policy at the Yellen Fed and fiscal policy from the Trump White House and GOP congress. But I saw this coming (via the New York Times):
For President Trump and his economic advisers, the strong February jobs report was a cause for celebration — and a first step toward delivering on the president’s promise of faster economic growth. For the Federal Reserve, it was the final confirmation that the time had come to raise interest rates to prevent the United States economy from overheating. Mr. Trump and Janet L. Yellen, the Fed’s chairwoman, appear to be headed toward a collision, albeit in slow motion. Mr. Trump has said repeatedly that he is determined to stimulate faster growth while the central bank, for its part, is indicating that it will seek to restrain any acceleration in economic activity.
So what happens when the Fed chair and the US president see things differently? Or what set of circumstances previously led the Fed to badly fall behind the tightening curve? A new Goldman Sachs research note highlights “a cautionary tale from US monetary history” recently told by Richmond Fed President Jeffrey Lacker. GS:
During the first half of the 1960s, inflation was consistently below 2% as the labor market gradually improved. But when the unemployment rate dipped below 4%, eventually falling as low as 3.4%, inflation, inflation expectations, and wage growth all rose sharply as the Fed failed to keep up. What went wrong in the mid-60s? Lacker and others highlight several factors. First, the Fed’s labor market targets were probably overambitious due to political pressure from the Johnson administration, whose Council of Economic Advisers opposed tightening before unemployment reached 4%. Second, Fed Chair William McChesney Martin also faced strong pressure from Johnson, members of Congress, and some fellow FOMC participants not to offset fiscal stimulus from the Great Society program and the Vietnam War. Third, Fed officials worried about the spillover effects on European economies of US monetary tightening. Fourth, when initial tightening led to a sharp downturn in the housing market in 1966, the Fed temporarily reversed course. Later, in the 1970s, inflation reached double-digit levels as political pressure on the Fed continued under Nixon and energy price shocks spilled over to core inflation after expectations had become less stable.
Now Goldman isn’t predicting a repeat with Trump vs. Yellen or Trump vs. the next Fed boss. More like something to keep an eye on. Caution, not alarm. And there are key differences between now and then, including the anchoring of inflation expectations and the general (un)willingness of the Fed to run a “high pressure economy” despite some musing about it. And as for now, the Fed may only be “modestly to moderately behind the curve.” GS sums up the risk factors:
Published in EconomicsFirst, the Fed has not always been immune to political pressure, a consideration that is still relevant in the context of recent Fed reform proposals. Second, balancing the needs of the US and global economies can be challenging. Third, tightening affects some sectors disproportionately, such as rate-sensitive housing or FX-sensitive manufacturing, and there may be a temptation to back off as a result.
Does this mean I can finally draw interest on money deposited in a savings account?
I think there is also a desire to get interest rates back to a somewhat “normal” level so they have some arrows in their quiver for the next downturn.
Of course the effects of “normal” interest rates on the National Debt will be devastating. All setting up an interesting scenario where the temptation to let inflation knock down the debt and give the government some chance of remaining solvent rather than reforming entitlements may be irresistible.
I have been worried about a Fed Hike for some time.
Not only will higher rates dramatically raise the budget deficit, but the Stock Market, Bond Market and Real Estate Market all have priced in the expectancy of extremely low interest rates and will all crash in a very big way if rates are increased in any substantial way.
The Bernacke/Yellen Fed put us into a real fix. Yes, we need to raise interest rates to save the insurance industry and pensions funds, and to actually start to raise capital again. But to avoid a major crash of the markets we need right now a major engine of job and economic growth to offset the real pain higher interest rates will have on the markets.
To be able to raise interest rates, we need to pull out all the stops- meaning :
• Major cuts in taxes on Personal Income, Corporate Income and Capital Gains.
• A systematic reduction in regulations at the State and Local Levels as well as at the Federal Level.
• We must find a way to start funding start-ups again. Without small business growth through new start-ups, the economy will be dead in the water.
• A realization that the lack of appropriate infrastructure spending in places like my home state California over the last 40 years has choked off growth through denial of access to the cheap land on the periphery of major metropolitan areas for inexpensive mass produced housing and building of industrial facilities.
All of this will get done after the factions of the GOP have torn each other apart over health care, if by some miracle we still have control of both houses…Don’t count on it.
This problem has a long history. Alan Greenspan spoke for years about “irrational exuberance” and warned that the economy was growing at unsustainable rates that would lead to bubbles in various sectors. But he kept rates low to give Bill Clinton the benefit of robust growth.
Bernanke and Yellen both entered office with rates at historic lows and kept them there.
We have had unrealistically low rates for nearly 30 years now; an entire generation does not know what it means to have “high interest rates.”
I don’t know where we are headed, but every time I think about how this might all play out, I get a queasy feeling.
I bought my first home with a 14.75% adjustable rate mortgage in 1981. Those were the Carter years of painfully high inflation. Up until that time home mortgages remained very stable since WWII at about 6%. Savings accounts paid about 5% interest, and although they didn’t exist then, 5 year CD’s would have been going for about 6%. That is in my view the proper and stable norm. It allows for savers to earn without large risks involved in the stock market. When rates came down to 7 3/4% in the late eighties, I doubled my payment, eliminating my mortgage in about 15 years.
It is hard for me to believe that the market has not already factored into its pricing an increase in interest rates. As long as Yellen operates with a steady hand, slow as you go, approach, things should be fine. More important is tax policy and regulations. The GOP should have done tax reform first. It’s a tough call, but they are in more agreement in that area and could have gotten a win under their belts right away. With the economy churning, healthcare would than be allowed the time needed to reconcile difference and end up with a winning law.
So what happens when the Fed chair and the US president see things differently?
If it’s 0bama, Yellen does his bidding. He held back rate increases.
If it’s Trump, Yellen will act independently. Trump approves of increases …
https://www.youtube.com/watch?v=iqhaq52SiXg