By Rik W. Hafer and Howard J. Wall
Chairman Jerome Powell delivered expected news following the Federal Reserve’s December, 2018 meeting: The benchmark policy rate—the Federal funds rate—would be raised by 25 basis points, putting it in the range of 2 ¼ to 2 ½ percent. What wasn’t expected was the Fed’s lowered growth projections for 2019. This announcement prompted a drop in stock markets, deepening the downward trend that began in October.
According to reports, in the days following the announcement a frustrated President Trump floated the idea of firing Powell for this decision. And the markets dropped some more.
The president’s reaction to the Fed’s decision was not surprising. He recently called the Fed “loco” and that he was “not even a little bit happy” with his nomination of Powell to be Fed Chair. What really startled observers was President Trump’s direct threat to the independence of the Federal Reserve and its chairman. Concerns ramped up when the president declared via Twitter on Christmas Eve that the Fed is the “only problem our economy has.”
Although President Trump’s methods and language of criticizing the Fed are new, presidential outbursts against the Fed are not uncommon. Trump’s recent rants are a revival of a presidential tradition.
In December 1965, the Federal Reserve, under the leadership of William McChesney Martin, raised the discount rate—the rate that banks could borrow money from the Fed at—to 4.5 percent from 4 percent. Raising interest rates was done to quell what the Fed perceived as an increasingly inflationary economy. President Johnson only viewed it as counter to his intentions of waging a costly war and pushing forward costly domestic programs.
So Chairman Martin was summoned to Johnson’s Texas ranch. By some accounts he not only was rebuked verbally, but physically backed up against a wall as Johnson laid into him for what the president believed was a policy detrimental to the country’s health and well-being. Martin did not, however, alter the Fed’s policy.
Paul Volcker relates a similar meeting with President Reagan in 1984 ahead of the elections. Summoned to the White House, the message he received was as clear as the one sent by Johnson to Martin. Meeting with only President Reagan and his Chief of Staff James Baker, Volcker writes that Mr. Baker telling him point-blank that “The president is ordering you not to raise interest rates before the election.” Can’t be much more direct than that. Even so, Volcker and the Fed continued to raise the funds rate through September.
Most Fed Chairs have, at one time or another, been subjected to political pressure over their policies. Whether it is by the sitting president or members of Congress—Congressman Henry Gonzalez (D-Tex) was infamous for constantly trying to impeach the Fed chair and Board members in the 1980s—such pubic assaults go with the territory.
But the key point is that, unlike most other central bank systems around the world, the Federal Reserve is a politically independent arm of the government. Though created by Congress, its independence allows it to conduct monetary policy without undue political manipulation. The Fed is able to conduct policy as it sees fit, enduring the wrath and indignation of presidents and politicians, who have disagreed with its policy actions.
We have followed monetary policy and, as Fed economists, have even participated in the making of it for the better part of the last 40 years. Was the Fed’s recent decision correct? Even the two of us disagree on certain aspects of a rate increase. But what we totally agree on, as backed by a vast amount of research, is that the Fed’s actions should never be used to satisfy the expectations of those in any one market, whether it is the market for stocks, houses, or foreign exchange.
The Fed must focus its actions on controlling the rate of inflation over time, regardless of the political pressures placed on the Fed. Failing to do so could produce a replay of the 1960s and 1970s, when inflation rose from 2 or 3 percent to double digits. And thus, the recent increase falls into that category.
EDITOR’S NOTE: R.W. Hafer is a professor of economics and director, Center for Economics and the Environment at Lindenwood University. Howard J. Wall is a professor of economics and director, The John W. Hammond Institute for Free Enterprise at Lindenwood University.
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