Trump’s arm-twisting of the Fed is what’s truly ‘loco’
President Trump keeps saying that Democrats want to model the United States on Venezuela. But the only one actually trying to turn us into Venezuela is Trump.
As stock markets plummeted last week, Trump lashed out at the Federal Reserve. He blamed the central bank, and not his trade wars, for the bloodbath.
“The Fed is going wild. I mean, I don’t know what their problem is that they are raising interest rates and it’s ridiculous,” Trump told Fox News. “The Fed is going loco, and there’s no reason for them to do it. I’m not happy about it,” he said.
While economists may disagree about the exact pace of interest-rate hikes, raising rates now — gradually, after keeping them at historically low levels for more than a decade — is hardly “loco.” You know what is “loco,” though? The fact that Trump thinks it’s appropriate to armtwist the Fed, whose political independence is supposed to be sacrosanct.
There’s good reason to safeguard central-bank independence: It’s that we don’t want to turn into Venezuela. Or Argentina. Or pre-euro Italy. Or basically any hyperinflationary basket case whose population doesn’t believe that monetary policy is free of political influence.
As these economies have shown many times over, putting the money supply in political hands is disastrous.
Politicians are always tempted by easy-money policy, especially in an election year. Why? In the short term, at least, loose monetary policy can goose the economy. It squeezes out a little more growth, boosts asset prices (including stocks) and pushes down unemployment.
Loose monetary policy can also lead to inflation, especially when the economy is already doing well.
If the public doesn’t believe the government is committed to keeping prices stable — because, say, an election is coming — businesses might start pre-emptively jacking up prices. Which leads customers to go out and buy up products before prices rise further, which can lead to further price hikes, and so on.
In other words, an inflationary spiral. The solution is to shield decisions about the money supply from day-to-day politics. In the United States, we do this by outsourcing decisions about interest rates to the Federal Reserve.
As an independent institution, whose officials are nominated by the president but can be removed only for cause, the Fed is free to do unpopular things, even in election years: to “take away the punch bowl” just when the party gets going — to prevent the economy from overheating. Or even to cause some near-term pain in service to longer-term price stability, as then-Fed Chair Paul Volcker did when he raised rates to tame out-of-control inflation.
The Fed hasn’t always been free of political influence. The high inflation that Volcker doused has been blamed in part on political pressure placed on Fed chairmen by the Johnson and Nixon administrations.
But for the most part, for the past several decades, administrations have maintained a policy of not commenting on monetary policy. They understood that a compromised Fed was just too risky.
Trump clearly has no such understanding. He wants more punch for everyone, at least while he’s president, and he wants to be the one who serves it. In fact, in May, former Fed Gov. Kevin Warsh told Politico about his own interview for the Fed chairmanship, in which Trump did not seem to understand that the Fed is supposed to be independent.
While the Fed has undoubtedly made mistakes in the past, it has spent decades cultivating its reputation for independence, and independence has been crucial to its ability to make a credible commitment to stable prices and thus the long-term health of the economy. Trump would do well to remember that reputation — fairly or not — is always easier lost than won.