Desmond Lachman ponders the potential impact of President Donald Trump’s approach toward the Federal Reserve.
It would never be a good time for the president to undermine the Federal Reserve’s independence. However, it would seem to be a particularly bad time to do so today. The country’s public finances are in a terrible state, the dollar is on the back foot, and President Donald Trump’s import tariff policy is already sowing doubts among foreign investors about America’s reliability as an economic partner. This makes Trump’s most recent frontal attack on Fed chair Jerome Powell particularly ill-advised.
Anyone doubting that Trump intends to bring the Federal Reserve fully under his control to lower interest rates has not been paying attention. He has repeatedly criticized Federal Reserve Chairman Jerome Powell in public for not drastically reducing interest rates; sought to remove Governor Lisa Cook from the Fed’s board; made new appointments to the Fed’s board who will do his bidding, and intimated that he will appoint a monetary policy dove to replace Powell as Fed chair when his term expires in May.
Now, Trump is stepping up the pressure on the Fed by taking the unprecedented step of having the Department of Justice bring criminal charges against Powell for allegedly misleading Congress about a $2.5 billion renovation project. Trump seems to be doing so to send a signal to Powell’s future replacement as well as to remove Powell from the Fed’s board after his term as Fed chair expires.
The clear danger of undermining the Fed’s independence is that it could lead to a rise in inflationary expectations. It could do so as investors come to believe that the Fed’s primary goal is to satisfy Trump’s quest for lower interest rates rather than to meet its 2 percent inflation target. In turn, that could lead investors to demand higher US Treasury bond yields to protect them against the prospect of higher inflation.
A key point that seems to elude Trump is that the Fed’s short-term interest rate is not the most important rate for the economy, but rather the 10-year Treasury bond rate.
