The Fed Should Ignore Trump and Contemplate Cuts for the Right Reasons
There is a danger if Fed policy makers err on the side of caution just to show their independence
Central bank independence rests on a shaky platform, and the Federal Reserve’s is especially wobbly. As policy makers prepare to discuss rate cuts, they face double trouble politically. Cutting rates to compensate for the damage done to the U.S. economy by tariffs risks co-opting the Fed into Donald Trump’s trade battles. Worse, easing looks like the Fed is caving in to Mr. Trump’s public demands for rate cuts.
So far Fed chairman Jerome Powell has done a good job of avoiding political controversy, insisting that Mr. Trump holds no sway inside the Fed. But he knows that any perception that the Fed is doing the bidding of the White House would damage its credibility with markets, one of its most powerful tools.
The real danger isn’t that Fed independence is compromised, or at least not yet. Instead, the danger is that the need to show their independence leads policy makers to err on the side of caution, perhaps waiting longer than they otherwise would to show they aren’t being pushed around. At a time when the need for easier money is debatable, it would be natural for policy makers to snub Mr. Trump’s calls for cuts to prove their impartiality. But it would be a mistake.
Start with trade. The tariffs threatened on Mexico have been suspended, but the pending extension of 25% import taxes to all Chinese goods will most likely push up prices in the U.S. and slow the economy. The Fed should look through the immediate price rises and focus on the longer-term damage that would be done to the economy, which would lead to more unemployment and lower inflation than would otherwise have been the case.
China tariffs are unlikely to throw the U.S. into recession on their own (although if they prompted a market crash the combined effects could be much worse). But yet more tariffs should lead the Fed to at least consider lower rates, even if that makes it look as though they are helping out the president.
The broader global slowdown in growth also pushes the Fed toward lower rates. Growth forecasts have been cut, inflation is expected to be moribund almost everywhere in the developed world and other central banks are hinting at easing, or in a couple of cases are already easing. A weak jobs report Friday in the U.S. doesn’t help matters. If the Fed does nothing, the shift in monetary policies overseas will tend to push the dollar up, a de facto tightening in the U.S.
The Fed has three big advantages when it comes to preserving the appearance of independence. It has decades of credibility. It has its record from last year, when it raised rates in the face of the Trump tax cuts, as an independent central bank should. And with the bond markets in a flap about the risks ahead, a rate cut wouldn’t come as a surprise to anyone.
Still, the Fed should be prepared for gleeful tweets from Mr. Trump after any cut, and there would surely be more questions if the Fed does what the White House wants. But the true test of independence isn’t cutting rates when Mr. Trump is right, or at least has a plausible case that they should be cut. The real problem would be to cut rates when Mr. Trump is wrongly demanding a cut.
At the moment it isn’t nearly as obvious as either Mr. Trump or the bond market thinks that rates need to be cut, let alone that they need to be cut a lot. Fed policy makers have made clear recently that cuts are possible, if only as an insurance policy, and Mr. Powell last week acknowledged that Mr. Trump’s trade conflicts are a consideration. Still, the main problem isn’t that the economy is in trouble. The problem is that the economy is doing less well than expected. This matters a lot to markets, which price performance against expectations. But the Fed will be looking at the outlook, which is for so-so growth at a time when the U.S. is managing the rare trick of having plentiful jobs and reasonable (if unspectacular) pay rises without much inflation.
There is a decent case to be made that there is a greater danger of inflation undershooting the Fed’s 2% target than overshooting it, which might justify an “insurance” rate cut. But some in the market are worried that much more might be on the way; for the first time there is a non-negligible chance of five cuts this year, equivalent to one at every meeting, and by December three cuts are priced as more likely than not. That would require things to go badly wrong, and the Fed to be worried that the economy has stalled.
If the trade conflicts worsen and there is a serious fall in stocks, then a dire economic outcome and several rate cuts would be plausible. But so long as the economy keeps up at least the dreary growth of the past decade it is hard to see why the Fed would move to panic stations—whatever Mr. Trump asks for.