Fed bash­ing is a fool’s game

The Telegraph (Macon) - - Opinion - BY LAWRENCE H. SUM­MERS Lawrence H. Sum­mers was trea­sury sec­re­tary from 1999 to 2001.

Pres­i­dent Don­ald Trump has pub­licly re­buked Fed­eral Re­serve Board Chair­man Jerome Pow­ell for what the pres­i­dent re­gards as mis­guided in­ter­est-rate in­creases that threaten con­tin­ued eco­nomic ex­pan­sion. This way of do­ing busi­ness is coun­ter­pro­duc­tive – ir­re­spec­tive of what­ever merit Trump’s un­der­ly­ing po­si­tion may have.

No cen­tral banker can be seen as yield­ing to pres­sure from a politi­cian fac­ing a dif­fi­cult elec­tion. A cen­tral bank that ap­pears sub­servient to po­lit­i­cal con­cerns will rapidly lose cred­i­bil­ity in the mar­kets, re­sult­ing in in­creases in in­fla­tion expectations and ris­ing longterm in­ter­est rates. As those of us at the Trea­sury Depart­ment used to re­mind White House po­lit­i­cal staff dur­ing the Clin­ton ad­min­is­tra­tion: Fed bash­ing is a fool’s game – the Fed doesn’t cut short rates, and the mar­ket raises long-term rates. The sense that pol­icy is be­ing politi­cized in­creases un­cer­tainty, which is likely to de­crease in­vest­ment and ul­ti­mately slow growth.

So Trump is surely mak­ing a se­ri­ous er­ror. Two ques­tions re­main. First, how rapidly should the Fed raise in­ter­est rates in com­ing months? Sec­ond, what should be the na­ture of re­la­tions be­tween the cen­tral bank and the ex­ec­u­tive branch? On nei­ther ques­tion does or­tho­dox think­ing seem quite right to me.

On the first ques­tion, it seems there is con­sid­er­ably more dan­ger of the Fed rais­ing rates too fast than too slowly over the next year. In­evitably, mon­e­tary pol­icy is a judg­ment about com­pet­ing risks. If the Fed raises rates too slowly, in­fla­tion will in­crease and re­main clearly above the 2 per­cent tar­get for a sig­nif­i­cant in­ter­val. This does not seem like it should be a dom­i­nant worry. In­fla­tion has been be­low the tar­get level for a decade, so above-tar­get in­fla­tion is nec­es­sary if in­fla­tion over the long term is to av­er­age 2 per­cent.

Even with good luck and good pol­icy, a re­ces­sion will come along at some point and pull down the in­fla­tion rate. Two months ago, it might have been rea­son­able to worry about com­pla­cency in as­set mar­kets, but in light of re­cent volatil­ity, this seems a lower-or­der prob­lem.

On the other hand, the risks of ex­ces­sive tight­en­ing seem sub­stan­tial. Mon­e­tary poli­cies af­fect the real econ­omy with lags of a year or more. It is, there­fore, easy for pol­icy to tighten past the point at which the econ­omy is thrown to­ward re­ces­sion be­cause of an ab­sence of clear sig­nals of slow­ing. In­deed, on al­most ev­ery oc­ca­sion in the past 50 years when the Fed has tight­ened in a sus­tained way, the re­sult has been re­ces­sion. The risks of a down­turn now are greater than at any point in liv­ing mem­ory be­cause, given the zero lower bound on in­ter­est rates, the Fed would have lim­ited room for eas­ing, and be­cause of the pop­ulist and pro­tec­tion­ist pres­sures that would al­most cer­tainly ac­com­pany a down­turn.

Sec­ond, there is a need for prag­ma­tism re­gard­ing the in­de­pen­dence of cen­tral banks. It is im­por­tant they re­sist the kind of pres­sure for in­fla­tion­ary pol­icy that Trump has en­gaged in. But it is fool­ish to sup­pose that a na­tion’s fi­nan­cial poli­cies should be con­ducted en­tirely in­de­pen­dently of its elected of­fi­cials.

The point is not that cen­tral banks should be made more sub­ject to po­lit­i­cal pres­sure. It is that, as their ac­tiv­i­ties ex­pand be­yond pure mon­e­tary pol­icy, there will be a need for co­or­di­na­tion be­tween the banks and elected govern­ment.

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