Despite Trump’s needling, the Fed stands its ground

Wednesday, the Federal Reserve’s decision-making body, the Federal Open Market Committee (FOMC), did not change the federal funds rate at its meeting.

In a more sane political environment, the decision not to change Fed policy during a fairly strong economic expansion might have been uncontroversial, barely worthy of mention. But Wednesday’s decision seemed to require a considerable degree of stoic determination.

{mosads}First, the economic case: Recent data showed the U.S. economy growing by an unexpectedly rapid 3.2-percent in the first quarter of 2019. While that number may be less than meets the eye, it still is well below the pace most economists believe the economy can sustain in the long-term.

Similarly, unemployment remains at very low rates and wages are growing a bit. Inflation is also close to the Fed’s 2-percent target. Fed Chairman Jerome Powell summarized the state of affairs in the opening statement of his press conference: “The economy continues on a healthy path.”

In the pre-Great Recession world of monetary policy, such a state of affairs would probably call for pre-emptive increases in interest rates to forestall large wage and price increases. However, the low-inflation environment post 2008 seems to be different. It is hard to find compelling reasons to expect that the economy will overheat at the moment.

Central bankers seem to be adhering to the hokey adage: “If it ain’t broke, don’t fix it.” This economy could be better. There still may be a significant number of potential workers on the sidelines, not counted as unemployed because they have not looked for work in months, but willing to work if they could find jobs.

Wages are certainly not rising terribly rapidly, and they have been depressed by the years of crisis and slow recovery.

Still, there are dangers to pumping up the economy when it is already doing well. The rampant inflation of the 1970s was in part the result of overly optimistic assessments of the economy’s potential, along with aggressive attempts to keep the economy growing rapidly.

It seems quite relevant to recall the stimulus President Nixon gave to the economy in the run-up to the 1972 election. With wage and price controls in place, the fiscal and monetary accommodation produced rapid growth and low unemployment that bolstered Nixon’s re-election. By 1973, when the wage and price controls were lifted, inflation was taking off. The rest is history.

President Donald Trump is no student of history. He and his aides have been needling the Fed relentlessly with calls for interest rate cuts. His latest tweet called for a 1-percent cut to the fed funds rate and “some quantitative easing.”

These would be massive monetary policy steps; the Fed rarely moves interest rates as much as half a percent. It has never used quantitative easing in combination with interest-rate cuts either because quantitative easing is considered to be a last-ditch tool to be used when interest rates are effectively at zero and cannot be cut at all.

There are some signs of a possible slowdown. The 3.2-percent growth in GDP in the first quarter came largely through inventory increases, a sign that businesses are producing more than they can sell. Consumption and investment expenditures were weaker. And there are signs of significant weakness in Europe and China.

Still, there is plenty of room for GDP growth to fall. Economists guess that the economy can only sustain about 1.8-percent growth, so a fall toward that figure would not be a disaster. Furthermore, the March data on consumption expenditure looked strong, suggesting that there is no imminent downward spiral.

In short, it is far from clear that a recession is in the cards. Central bankers do not believe that they can anticipate and prevent recessions.

They have been entrusted to make these decisions precisely because politicians have such strong motivation to throw caution to the wind in the service of re-election hopes. History has shown us the damage that such a “political business cycle” can create.

{mossecondads}Powell must feel the political pressure. Recently, President Trump indicated that he would nominate two candidates for the Fed’s Board of Governors who are both poorly qualified as economists and extremely loyal to the president.

Though Herman Cain withdrew his candidacy from consideration, Stephen Moore appeared ready to press on in the face of broad opposition from the economics community and skepticism even from some Senate Republicans. But on Thursday, Moore withdrew his nomination, as well.

The FOMC’s usual statement accompanying its decision was unusually terse, perhaps reflecting a circling of the wagons in this fraught moment.

This time, the Fed has stood its ground. We will have to wait a while longer for the next shoe to drop.

Evan Kraft is the economist in residence for the Economics Department at American University. He served as director of the Research Department and adviser to the governor of the Croatian National Bank.