Messing with Fed is potentially dangerous

With an election approaching and unwilling to take his chances on the vicissitudes of an economy growing at the respectable rate of more than 3 percent, President Richard Nixon in December 1971 delivered an Oval Office pep talk to Federal Reserve Chairman Arthur Burns about how to move Burns’ colleagues at the Fed off their resistance to a pumppriming cut in interest rates.

“You can lead ‘em. You can lead ‘em. You always have,” Nixon assured Burns. “Just kick ‘em in the rump a little.”

Until President Donald Trump’s more public rump-kick to Fed Chairman Jerome Powell last month, Nixon’s call to action — captured on tape, of course — is the last known attempt by an American president to directly influence monetary policy. Not that others haven’t been tempted.

President Jimmy Carter could not have been pleased when Paul Volcker, his appointment to head the Fed in 1978, subsequently jacked up short-term interest rates to double-digits, throwing another roadblock into Carter’s reelection chances.

In 1982, with benchmark rates 13 percentage points higher than now, President Ronald Reagan declined to bully Volcker into taking his lead foot off the monetary brake, despite a brutal recession that drove unemployment to nearly 10 percent.

“I have met with Chairman Volcker several times during the last year,” Reagan said. “I have full confidence in the announced policies of the Federal Reserve.”

Hands off

Carter, Reagan and their successors through Barack Obama knew enough to leave a good thing alone. An independent central bank is an invaluable asset, but one that is vulnerable to pressure from populist and authoritarian governments, like those in Turkey and China.

In a paper published by the Federal Reserve Bank of St. Louis, Allan H. Meltzer argued that the “Great Inflation” of 1965 to 1984 “cannot be understood fully without its political dimension.”

Though Trump later claimed to respect the Fed’s independence, his remarks were clearly intended to dissuade Powell and his cohorts on the Fed’s rate-setting committee from continuing down the path of monetary normalization.

Under normal conditions, that path would seem to have much further to go.

Benchmark interest rates are about one percentage point below headline inflation, or about where they were during the crisis-free portions of the 1970s, but nearly three percentage points under their longer-run average. And with the U.S. economy growing at its fastest pace since 2014 and running out of spare capacity, now would seem an odd time to keep the monetary pedal to the metal.

Which is where the Trump administration’s unorthodox policies have businesses and workers thankful, hopeful and vexed.

Thankful because last year’s tax cut propelled Corporate America into a kind of financial nirvana, with second quarter profits climbing by almost 25 percent over last year.

Hopeful because lower taxes leave companies with more money for productivity-enhancing investments whose financial rewards might eventually trickle down to workers.

Vexed because the bulk of the benefits have gone to shareholders and executives, the latter of which often have compensation packages tied to their company’s stock price. Through June, U.S. corporations had plowed over $600 billion into buying back their shares, funds that might have been used to raise wages and invest in new plants and equipment.

Potentially dangerous experiment

As a “real estate guy,” Trump under- standably likes low interest rates, which reduce financing costs and drive up inflation, thus boosting the value of real assets, like property. But political pressure from the White House notwithstanding, the Powell Fed soon will face decisions that could shape the country’s economic future, possibly for decades.

So far, the incremental rate hikes begun by former Fed Chairwoman Janet Yellen and continued by Powell have been easy calls.

Not so going forward.

It’s possible that the deflationary impact of the internet has fundamentally changed the economic playbook. Still, the massive fiscal stimulus that passed Congress in December — at a time when monetary policy also was relatively loose — represents an extraordinary and potentially dangerous experiment, administering a sugar high to an economy in the later stages of a business cycle when cost pressures typically are building.

If history repeats and a surge in inflation causes the Fed to slam on the brakes, Powell’s won’t be the only rump to get kicked.

Tom Saler is an author and freelance financial journalist in Madison. He can be reached at tomsaler.com.