Jerome “Too Late” Powell and Federal Reserve Independence

In case you missed it, Jerome Powell and the Fed decided to hold rates steady at their meeting yesterday. This time around, though, there were two dissenters, voting to lower rates, though not by as much as Trump wants out of the FOMC.

Note: I’m going to write very informally here. There is a lot of nuance that would matter if this were, for example, an upper level Money & Banking course. But it’s not.

The Fed’s dual mandate is to promote price stability and full employment. These two goals are often at odds. If there is high unemployment, the Fed could combat this by lowering interest rates… but that almost always triggers some amount of inflation. If there’s high inflation, the Fed could tighten the money supply… but that will often raise unemployment.

But here’s the real kicker: right now, based on the latest reports, inflation is ticking upward. This would normally be cause for tightening the money supply by raising the interest rate. But we’ve also got persistent fears of higher unemployment and underemployment, which would be cause for lowering the interest rate.

So what is the Fed to do in this scenario? Despite what some people may think, there’s really not a “right” answer. At some level, it comes down to the question, “which goal do you want to accomplish at the expense of the other?” If you care more about lowering inflation and promoting long term stability, then you’ll raise rates. If you care more about promoting full employment and short term stability, you’ll lower rates. This is a value judgement - no amount of “science” can tell you which one is objectively more important.

But let’s suppose that Fed officials think that they should lower the interest rate. We might think, then, that Jerome Powell should just… lower the interest rate, right? Well, I’d agree with that if it weren’t for this pesky person named “Donald Trump.”

No, I’m not trying to be anti-Trump here or anything. The problem I see here is that Trump has been trying to bully and cajole Powell into lowering rates for months now. If Powell does lower rates, is it because it’s the right thing to do or because the President finally wore him down and got his way?

If markets believe that it’s the former, cool. But if they believe it’s the latter, that’s a sign that Fed independence has waned or perhaps even been eliminated. And that is not a good thing at all.

But by defying the President, the Fed has ensured that no one can accuse them of anything other than being independent. That might be worth preserving, even at the expense of not lowering interest rates by a few basis points.