I actually unplugged last month and took a vacation. Once back home and plugged back in, I was surprised to see how far the dust up between President Trump and Fed Chair Jerome Powell had gone.
Most shocking of all was an op-ed by Bill Dudley, a former president of the New York Fed. Normally, Fed insiders are very careful to project a no-politics/pure-policy image, but there was Dudley, unvarnished, in Bloomberg:
There’s even an argument that the election itself falls within the Fed’s purview. After all, Trump’s reelection arguably presents a threat to the U.S. 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.
Obviously, political outcomes can affect the economy, and Dudley did sort of backtrack a few days later. But his column still constitutes the most blatant statement of its kind that I can recall from the last few decades. One has to wonder how Dudley and his colleagues factored in elections back when he was voting on the Federal Open Market Committee.
To his credit, Powell swiftly rejected the notion that the Fed should take the 2020 election into account, saying: “Absolutely not. Political factors play absolutely no role” in policy, [and that the] Fed serves “all Americans regardless of their political party…It’s just simply wrong. The answer would be a hard no.”
Of course, president Trump has not exactly tried to make the situation better.
On Friday, the president tweeted that "The Fed should lower rates. They were WAY too early to raise, and Way too late to cut,... Where did I find this guy Jerome?!” Given the months of presidential Fed bashing, this tweet was not all that surprising, especially compared to Dudley’s op-ed.
It is certainly healthy to debate whether the Fed’s policy stance has been too tight or too loose, but having the Oval Office publicly squabble over the Fed’s interest rate target is a bit odd, to say the least. Regardless of which side is right, the entire display is totally unnecessary.
The Fed provides system-wide liquidity. Sometimes it provides too much, sometimes it does not provide enough. Both of those mistakes have caused bigger economic problems in the past, and the debate the administration should be having is over how to build a system that does not hinge so critically on a government agency avoiding those missteps.
Whether the Fed’s rate target should be 2.25 percent or 2.0 percent is, on its own, almost pointless. The Fed cannot control “interest rates” to any real degree, and the important question over its policy stance is whether the Fed has caused a nominal slow-down in the economy because of a liquidity shortage, regardless of that rate target.
Worse, though, is that these theatrics distract people from more important reasons that the administration should be working to reform the Federal Reserve. Aside from moving to a wholly reformed monetary system, here’s a short list of issues where it would be much better for the administration to shift its focus.
Interest on Excess Reserves and the Fed’s Floor System. During the 2008 financial crisis, the Federal Reserve purchased large quantities of long-term Treasuries and mortgage-backed securities. Partly because of those purchases, the Fed also implemented a number of experimental monetary policy tools that it has yet to end, such as its new operating framework (the floor system) that pays interest on banks’ excess reserves. This operating framework effectively divorces the Fed’s monetary policy stance from the size of its balance sheet, and it distorts markets because it replaces a market-determined federal funds rate with a bureaucratically administered rate. To genuinely normalize monetary policy, the Fed has to shrink its footprint and end its experimental programs.
The Fed’s Role in the Payments System. The Fed recently decided to move forward with creating its own real-time payment system, a move that is completely unnecessary and counterproductive. But that decision only highlights the bigger underlying issue: The Fed is intricately involved in the nation’s payment system in many ways that it does not have to be. Ultimately, this pervasive reach only serves to entrench the biggest players in the banking industry at the cost of innovation and new economic opportunities. With regard to electronic payments, no financial technology firm can avoid dealing with a bank and/or the Fed at some point in their operation, generally slowing down the rate at which new payment methods benefit consumers. Treasury should issue a new report that studies the payment system and focuses on all the ways that private firms can replace the Fed’s roles in payments.
The Fed’s Growing Reach as a Regulator. As required by Dodd-Frank, the Fed recently proposed a new set of risk-based capital rules for large insurance companies, even though these firms are already subject to state-based standards. These rules are the tip of the iceberg: Dodd-Frank expanded the Fed’s role as a regulator both inside and outside of the banking industry, even where other federal regulators already exist. To its credit, the administration has worked on improving Dodd-Frank era rules, but not one single title of the Dodd-Frank Act has been repealed, and the administration seems fine with the underlying principles behind the Financial Stability Oversight Council (FSOC), a Dodd-Frank created council of regulators with the Fed at the top. Because of the FSOC’s ill-defined mandate to stamp out risks to U.S. financial stability, financial companies of all sizes now operate under the constant threat of having new, company specific, regulations thrust upon them for virtually any reason the FSOC can come up with. That’s not the type of regulatory environment that helps companies grow. For a president who campaigned on the promise that his administration was “going to be doing a big number on Dodd-Frank,” it’s long past the time to start actually getting rid of that law.
The people who created the Fed would barely recognize what it has become. All the back and forth chatter about interest rates might be great political theater, but if the president wants to take major steps toward unleashing economic growth, he will shift his focus away from the Fed’s target interest rate.
This piece originally appeared in Forbes https://www.forbes.com/sites/norbertmichel/2019/09/09/the-president-should-stop-wasting-energy-on-interest-rates/#707f0c20658d