Protocol means little to President Trump. Ahead of Summits with North Korean dictator Kim Jong-un and Russian President Vladimir Putin, his Administration negotiated no advance diplomatic agreements and the President spent minimal time preparing for his meetings. Ahead of the June 1, 2018 release of the May employment data, President Trump tweeted that he was “looking forward” to the report, one that he had seen in advance of its public release. On Thursday, he fired his first shot at the Federal Reserve, expressing dissatisfaction with its ongoing gradual tightening of monetary policy.
In a stinging and historically rare criticism, President Donald Trump expressed frustration with the Federal Reserve and said the central bank could disrupt the economic recovery…
“I’m not thrilled,” he told CNBC’s Joe Kernen in an interview… “Because we go up and every time you go up they want to raise rates again. I don’t really — I am not happy about it. But at the same time I’m letting them do what they feel is best.”
Afterward, as happened repeatedly following the very recent Helsinki Summit, the White House clarified that President Trump did not intend to influence monetary policy. Of course, by that time, President Trump had made his point.
Central bank independence is crucial to sound macroeconomic outcomes. At a May 25, 2018 speech at Sweden’s Riksbank in commemoration of the 350th anniversary of central banking, Fed Chair Jerome H. Powell addressed the vital importance of central bank independence. Powell told his audience (Federal Reserve):
This is a challenging moment for central banking. Opinion polls show that trust in government and public institutions is at historic lows. In this environment, central banks cannot take our measure of independence for granted.
For monetary policy, the case for central bank independence rests on the demonstrated benefits of insulating monetary policy decisions from shorter-term political considerations. But for a quarter century, inflation has been low and inflation expectations anchored. We must not forget the lessons of the past, when a lack of central bank independence led to episodes of runaway inflation and subsequent economic contractions…
Within our narrow mandates, to safeguard against political interference, central banks are afforded instrument independence that is, we are given considerable freedom to choose the means to achieve legislatively-assigned goals. While the focus is often on monetary policy independence, research suggests that a degree of independence in regulatory and financial stability matters improves the stability of the banking system and leads to better outcomes. For this reason, governments in many countries, including the United States, have granted some institutional and budgetary independence to their financial regulators.
Political interference with central bank monetary policy making has been rare, but not unknown in the United States. In the run-up to the 1972 Presidential election, President Richard Nixon successfully pressured Fed Chair Arthur Burns to ease monetary policy, even as economic growth was accelerating. Burton A. Abrams, Professor of Economics at the University of Delaware explained in an article published in the Fall 2006 issue of the Journal of Economic Perspectives (St. Louis Federal Reserve):
In 1969, President Richard Nixon nominated Arthur F. Burns as the chairman of the Federal Reserve, and Burns took office on February 1, 1970. Burns was a respected economist with years of experience and impressive credentials…
Evidence from the Nixon tapes, recently made available to researchers, clearly reveals that President Nixon pressured Burns, both directly and indirectly through Office of Management and Budget Director George Shultz, to engage in expansionary monetary policies prior to the 1972 election.
…a monetary stimulus helped boost the economy in time for the 1972 election, helping to deliver Nixon’s landslide victory. However, the excessive aggregate demand stimulation prior to the election created serious problems for the economy that took nearly a decade to resolve.
President Nixon had even considered the possibility of expanding the size of the Federal Reserve Board. Doing so would have permitted him to appoint a majority of its members and, thereby, install a more accommodating Board.
On account of the Fed’s easing, inflation became entrenched in the American economy (St. Louis Federal Reserve). The inflation rate rose quickly from 1972 onward. In 1972, consumer prices rose 3.4% on a year-on-year basis. In 1973, the consumer inflation rate more than doubled to 8.9%. In 1974 double-digit inflation arrived, with consumer prices soaring 12.1% for the year.
The inflation rate would ultimately peak in March-April 1980 with a 12-month moving average figure of 14.6% for both months. The 12-month moving average consumer price increase was 5% or higher every month for nearly a decade, from April 1973 through October 1982. Severe monetary policy tightening led by Fed Chair Paul Volcker triggered a significant recession that finally broke the back of that bout of prolonged rampaging inflation.
Why did President Trump express displeasure with the Fed’s policy of gradual tightening?
Perhaps it had something to do with concern that such tightening could gradually slow the economy, as Trump had stated. Given monetary policy lags, a slowing economy would be particularly unwelcome for the President should it coincide with the start of the 2020 election and his bid for re-election.
Perhaps he had something else in mind. Perhaps, his comments were a trial balloon or even an opening shot aimed at encouraging a sustained increase in inflation. Higher inflation would reduce the real value of the nation’s debt. The nation’s debt has been increasing relative to GDP under the Trump Administration’s fiscal policy. In This Time is Different: Eight Centuries of Financial Folly (Princeton University Press, 2009), economists Carmen Reinhart and Kenneth Rogoff explained:
The inflationary risks to monetary policy frameworks (whether the exchange rate is fixed or flexible) also seem to be linked in important ways to the levels of domestic debt. Many governments have succumbed to the temptation to inflate away domestic debt.
That President Trump might consider or even launch an inflation-based debt strategy is not entirely far-fetched. While seeking the Republican nomination, Donald Trump spoke of just such a scenario in May 2016. CNN reported:
“People said I want to go and buy debt and default on debt, and I mean, these people are crazy. This is the United States government,” Trump told CNN’s Chris Cuomo on “New Day.” “First of all, you never have to default because you print the money, I hate to tell you, OK?”
Based on his monetary policy philosophy and the importance he places on central bank independence, Fed Chair Powell will ignore the President’s unwelcome interest rate “advice.” But as the stimulative effect of the “Tax Cuts and Jobs Act” that was signed into law in December 2017 diminishes next year and the 2020 campaign begins to heat up, the President may well step up his pressure. If so, there may be no subsequent attempt to “walk back” his commentary.