[This post is drawn in part from a forthcoming policy brief co-authored with Simon Johnson]
Last week, I said that we should not expect the Trump-Republican coalition to have the same hawkish posture toward monetary policy that we saw within the Republican coalition during its anti-Obama years from 2009-2017. There are coalitional tactics and there are core principles: dovish monetary policy has been heartily endorsed by the party in power, whether Democratic or Republican. Donald Trump has given us every indication that he cares about monetary policy only as a subsidiary to the preservation of his own reputation and power. He’s no principled hawk, and those principled hawks in the Republican Party aren’t likely to prevail on him to give the Fed its space to pursue a monetary policy that has short-term negative political consequences for the President-elect.
But this change in Republican attitudes, if it comes, shouldn’t be welcome news to the Fed. Just the opposite. As Sebastian Mallaby has argued, Donald Trump’s twin promises of massive spending and lower taxes would produce exactly the kind of fiscal stimulus that should shoot up pressure on interest rates. And sure enough, the 30-year Treasury yields are up markedly since the election. This means that the widely anticipated rate hike in two weeks will be the beginning of a long process of rate normalization. That’s good news for those on fixed incomes, but could be very bad news for the Trump administration. If the Fed is raising rates throughout his presidency, and if those rates have a consequence of nudging up the unemployment rate, then there is a crisis brewing for the Fed. Donald Trump is a politician who backs easily refuted conspiracy theories about a hijacked election that he himself won. Why wouldn’t he go to the mats against an institution that is a hotbed for these kinds of conspiracy theories already?
If the foregoing is true—and nothing is certain—then there is a coming confrontation between the Fed and the President-elect that is almost without historical precedent. (The closest thing might be the epic fight between the Truman Administration and the Fed, but even that was fought on different terms.) The question, as I put it last week, is what can the Fed do about it?
As with every other aspect of the Fed’s “independence,” to use an often invoked but badly misunderstood term, there are legal and non-legal elements at play. In terms of the politics of it, the Fed could take a play from Alan Greenspan. Mallaby’s new biography of Greenspan makes clear that the former Fed Chair was a political counter-puncher par excellence. The Trump Administration will use its formidable political talents—and, rest assured, its Twitter accounts—to wage a political war on the Fed’s credibility. The Fed can and should fight back. The idea of a central bank that pursues its day-to-day functions outside the heat of the 24-hour cable news cycle has friends on both sides of the aisle, but monetary politics make for unwieldy coalitions. The Fed should not be passive in a political fight that the Trump Administration brings to its doorstep. Playing politics will be seen as illegitimate or inconsistent with its vaunted independence by some, but those views should be dismissed. The Fed is a political institution, embedded within a sea of political institutions. It cannot and should not (and, I should add, will not, if history is a guide) cede political ground entirely. This is not to say the Fed is a partisan institution, a distinction I’ll make clear in a moment. But it is a political one.
The rules of the game are different for the Fed, of course. It’s not going to cut attack ads to air in western Pennsylvania. But it will be deeply involved with its allies in Congress, including those principled hawks in the Republican Party who will find much to despise about an administration that goes to war with the central bank in an effort to bully it toward more inflationary monetary policy.
Tomorrow I’ll discuss the perhaps more interesting legal maneuvers that Fed insiders can pursue to act as a check on the Trump Administration, should that check be needed. For today, the bottom line is clear: if the Trump Administration brings partisan politics to the Fed’s front door, don’t count the Fed out. There will be tremendous political costs for assaulting the Fed’s autonomy, and we can count on the Fed raising those costs using every tool at its disposal.