On Tuesday, the president renewed his earlier criticisms of the Federal Reserve’s interest rates hike—saying he was not happy with the fast pace of the Fed’s “normalization” plan. This pattern has been reported as “breaking” with tradition and questioning the “independence” of the Fed. Then yesterday afternoon, after a plunge in financial markets, Trump sharpened his critique saying “the Fed has gone crazy.”
While it is—at least among recent presidents—unusual for the president to opine on monetary policy, this has been a most unusual presidency from the start. And while Trump’s criticisms of the Fed are good for generating headlines, they risk drawing attention away from more important matters at the central bank. To that end, I want to share two points to help put the president’s remarks in proper contexts—followed by two additional points to reorient the Fed discussion around what’s actually important.
One worry people have about Trump’s comments is that they call into question the Fed’s “independence.” But it is critical to remember that central bank independence is a somewhat amorphous term—with different speakers relying on different definitions. It is, however, a useful concept when independence refers to the Fed conducting monetary policy without regard to political considerations. That is to say, the Fed is an independent institution insofar as it sets policy in reaction to changing macroeconomic conditions—not in reaction to changes in the legislative agenda or electoral prospects. What is not, or should not, be meant by central bank independence is that the Fed is fully divorced from all other public institutions. Chair Powell often, and rightly, stresses that the Fed pursues goals given to it by Congress; in that respect, the Fed is certainly not independent from accountability to the public.
To the extent anyone is worrying that the Powell Fed will change policy based on Trump’s remarks, such concerns are unfounded.
On the policy front, the president seemed to suggest the Fed should wait on raising interest rates until “inflation [comes] back.” What threshold Trump has in mind when he says “back” is anyone’s guess, but inflation has been increasing. While this morning’s CPI release had month-over-month inflation below expectations, the Fed’s preferred inflation metric has moved up to their 2% target in recent months. And the ten-year forecast, put out by the Cleveland Fed, shows long-run inflation expectations have also increased of late and are now slightly above the Fed’s 2% inflation target.
These inflation data have been moving up as the Fed has been increasing their policy rates, suggesting that monetary policy has not become overly restrictive. Scott Sumner, in a post reacting to yesterday’s stock market developments, points out that while monetary policy was too tight it has recently moved towards a more neutral and appropriate stance. Remember, looking at just interest rates is insufficient to judge the actual stance of monetary policy. Therefore, at least for now, the Fed is likely to continue the normalization plan it has been talking about for years.
Of course, the Fed should not stick to this plan irrespective of any and all changes in the macroeconomy; indeed, I have been critical of their defense of rates increases in the past. But daily stock market volatility and the president’s response to it are not developments that should immediately change the Fed’s longer-term strategy.
For the astute people monitoring the Fed, the president’s comments ought to be largely ignored. It is far more important to pay attention to two conversations occurring within the Fed.
One conversation is about changing the Fed’s 2% inflation target. Several Fed officials have already endorsed their preferred strategies. Eric Rosengren, President of the Boston Fed, believes an inflation range, perhaps 1.5-3%, is best, while New York Fed President John Williams and Atlanta Fed President Raphael Bostic, want to adopt a new target altogether: a price level target. Ex-Fed officials have also joined the conversation, with former Fed Chair Ben Bernanke proposing a hybrid system that would move from an inflation target to a price level target when the policy interest rate got close to zero. There are very good reasons for the Fed to begin reconsidering its monetary policy target, but for this conversation to be truly beneficial the Fed should include an NGDP level target on the list of alternatives.
The second conversation, and one of more immediate concern, is about the Fed’s operating framework for executing monetary policy. The current framework—which pays banks an above market interest rate on their deposits held at the Federal Reserve in order to keep the effective federal funds rate within the Fed’s target range—was created during the financial crisis. The Fed is still learning about this new framework for setting interest rate policy and has already needed to tweak the framework once. Chair Powell has signaled that the FOMC will be exploring it further throughout the fall. For those interested in learning more about the potential issues embedded in the Fed’s new operating framework and why it is in need of reform, I would point you toward my colleague George Selgin’s summary of his forthcoming book Floored!.
There are important challenges facing the Fed and its conduct of monetary policy, and they deserve more attention than do the president’s rants.