Donald Trump is not happy with Jerome Powell, the chairman of the Federal Reserve. “Very dumb”, “hardheaded”, “a real dummy” and a “numbskull” (sic) are just some of the epithets he has used in recent months. He must be really cross with the person who appointed Powell to the job who was (checks notes) Donald Trump in 2017 (Powell took office in the following year). Mr Trump didn’t spot the supposed intellectual deficiencies in Mr Powell back then.
Mr Trump’s complaint is that the Fed has been too slow to cut interest rates. He is not the first President to argue this. The unfortunate Arthur Burns was Fed chairman during the Presidency of Richard Nixon; as part of his bullying campaign, “Tricky Dickie” leaked a false report to the press that Burns was demanding a 50% pay raise in order to make the Fed chairman unpopular. Burns kept interest rates low, giving a boost both to Nixon’s re-election bid in 1972 and to inflation, which soared in 1973 and 1974.
Mr Trump’s latest tactic is to show Republicans in Congress a draft letter firing Mr Powell. While he retreated from the threat later in the day, it was clearly designed to put pressure on the Fed chairman. The ostensible rationale for a sacking would be an overrun on refurbishment costs at the central bank.
The assault on the Fed is another aspect of the flawed policy approach of Donald Trump and features in my new book “The Economic Consequences of Mr Trump” published today.
Mr Powell, who is 72 and whose terms end next year, seems currently inclined to go out with dignity by pursuing the policy he thinks best for the economy. In this he might turn out to be that rare individual; someone who works for Mr Trump but emerges with his honour intact. (Think of all those generals and top businessmen, not to mention Elon Musk.)
So what should the Fed be doing? The inflation rate it targets is the personal consumption expenditures (PCE) index. In May, the annual PCE rate was 2.3%, slightly above the Fed’s target of 2%. The June figures won’t be revealed until July 31. But both the headline and core inflation rates for June have been announced, and they both show increases, to 2.7% and 2.9% respectively.
Inflation that is both above target and rising does not suggest the central bank should be slashing rates, let alone to the 1% level suggested by Mr Trump. As for economic activity, the first quarter numbers were very weak but the Atlanta Fed model suggests 2.6% annualised growth in the second quarter. The US unemployment rate is just 4.1%.
The Fed is understandably cautious because it is too early to see the impact of Mr Trump’s first round of tariffs on prices (let alone the second set), the recent budget was fiscally expansionary and Trump’s crackdown on immigration may also weaken US growth significantly. It makes sense to wait a bit and see what happens.
Central bank independence is appreciated by investors because they know elected politicians will demand consistent stimulus to boost their popularity. In the long run, the result will be higher inflation; the classic recent example was in Turkey where President Erdogan insisted on the bizarre notion that higher interest rates caused inflation. He ordered the central banks to cut rates and inflation duly jumped to 70%.
A Trump patsy in the Fed might lead to a similar problem, albeit on a smaller scale. So the President’s repeated attacks on Mr Powell prompt a sell-off in both Treasury bonds (thus higher bond yields) and the dollar. Those sell-offs have their own consequences; higher bond yields raise the borrowing costs of the government (making it harder to reduce the deficit) and of companies and homeowners.
That is because central banks depend very much on credibility. That is why they set inflation targets, publish forecasts and publish the minutes of their meetings. If businesses and consumers assume the central bank is serious about keeping inflation low, they will act accordingly, moderating prices and wages. In turn, that will make it easier to meet the target.
Of course, the Fed chairman only has one vote on the interest-rate setting committee. Still other members of the committee might well be influenced by the chairman’s lead (just as they were by Alan Greenspan and Ben Bernanke). And if monetary policy does become expansionary, that would coincide and interact with very expansionary fiscal policy.
Add in the tariffs, the loss of US soft power by alienating allies and the assault on the US’s great record in scientific research and the potential is for a disastrous legacy from Mr Trump’s second term.