President Trump really wants the Federal Reserve to cut interest rates. He's repeatedly accused the central bank of holding back economic growth and undermining his trade war with China. After the Fed paused its rate increases in January, Trump demanded rate cuts, and threatened to put at least two forthright cronies on the Fed board. Just this Monday, Trump went on CNBC and attacked the central bank again: "They certainly didn't listen to me because they made a big mistake. They raised interest rates far too fast."
The markets seem to think Trump will get what he wants. They're currently pricing in a 70 percent chance the Fed will reduce interest rates in July, and a 60 percent chance they'll cut three times in 2019. On the economic merits, the Fed would certainly be justified in doing so.
Yet the Federal Reserve may hold back. And if they do, it will most likely be because Trump decided to open his big mouth.
That the Fed should make its monetary policy decisions independent from the executive branch is a norm cherished by American elites across the ideological spectrum. But it was not always thus: Back during World War II, the Fed essentially took orders from the Treasury Department, and kept interest rates pegged very low to finance the government's massive war spending. But by 1951, Fed officials feared the perpetually low interest rates had opened the door to inflation, which had just cracked 21 percent. In two meetings early that year, the Treasury Department finally backed down, allowing the Fed to adjust interest rates as it saw fit.
Executive branch pressure didn't go away entirely, of course. The current conventional wisdom points to President Nixon in particular, for browbeating the Fed into keeping rates lower, and thus setting the stage for the inflation crisis of the 1970s. It wasn't until Fed Chairman Paul Volcker massively hiked interest rates and set off a brutal recession, ignoring massive public and congressional unrest in the process, that inflation was finally contained. That episode didn't really change the Fed’s relationship to the executive — Volcker had the support of both Presidents Carter and Reagan. But it did solidify the Fed's reputation as the institution that inflicts the unpopular but necessary pain to keep inflation down. The modern norm of Fed independence is really founded on the assumption that if the Fed loses its freedom to inflict that pain, inflation will take off again.
Of course, Donald Trump, being Donald Trump, has no use for your pesky norms. Not only does he routinely criticize the Fed in public, and call up Fed officials like Chairman Jerome Powell in private, but Trump also implies things would be better if U.S. monetary policy was run more like it is in authoritarian countries. In his CNBC interview, Trump noted that President Xi of China is also the head of the central bank there — "He can do whatever he wants," Trump mused — and complained that this gives Xi an unfair advantage in our two countries' ongoing trade fight. The message there is hardly subtle.
Thus far, Powell and the other Fed officials have dealt with Trump via a strict policy of non-engagement. Powell never mentions the president in his public statements, never responds to any attacks, and resolutely refuses to bring up politics when explaining the Fed's monetary policy decisions. Clearly, the chairman and his colleagues care deeply about the Fed's reputation as a politically independent entity, and want to preserve it. "We're never going to take political considerations into account or discuss them as part of our work," Powell insisted in January. "We're human. We make mistakes. But we're not going to make mistakes of character or integrity."
The problem is that, even if Powell isn't engaging with the president, everyone else still sees Trump's attacks. The Fed has already paused its interest rate hikes. If it cuts rates, it will just further increase the appearance of correlation between Trump's preferences and the central bank's decisions. There's anecdotal evidence that many investors and observers abroad already assume the Fed is bowing to Trump's bidding. Powell has been equally clear he won't do the opposite of what Trump demands simply for the sake of contrast. But every time Trump criticizes the central bank publicly, the pressure mounts for Fed officials to distinguish themselves. "By lowering borrowing costs, the central bank would be giving Mr. Trump exactly what he wants, creating a risk that it will look political even though it is acting on economic fundamentals," the New York Times observed.
Further complicating matters here is the question of whether the Fed's freedom is really worth preserving. The story above, about how loose monetary policy under Nixon led to inflation, has a few holes in it. Both the causes and the best solutions for the inflation crisis of the 1970s are disputable, to put it mildly. The modern era of Fed independence delivered low and stable inflation, to be sure; it also delivered income stagnation, rising inequality, jobless recoveries, mass economic insecurity, and an economy stuck in a near-permanent semi-slump. Indeed, if the Fed does cut rates this year, it would be a remarkable rejection of the general inflation hawkery that has guided the central bank for decades.
A responsible president could've dealt with these matters by getting into the nitty gritty of Federal Reserve appointments: questioning potential appointees on their theories of monetary policy, their read of Fed history, their takes on the causes of inflation, and their opinion of past decisions like Volcker's. A responsible president could also seek to reform the Fed itself: change its structure and its instructions from Congress to make it more democratic, and more accountable to the everyday workers whose job prospects rise and fall on the central bank’s decisions.
Instead, we got Trump, who is not a responsible president. He has the gumption to ignore elite opinion, but neither the intelligence nor the character to build a workable alternative. By all accounts, Trump initially handled monetary policy on autopilot, filling three vacancies on the Fed board and promoting Powell to Fed Chair based on whatever his White House officials advised. Then Trump disavowed the very people he appointed the second they didn't cooperate with his desires. "It's more than just Jay Powell," Trump told CNBC. "We have people on the Fed that really weren't — you know, they're not my people."
Now, to top it off, Trump could spook his own Fed officials, right as they may be working up the courage to do the right thing.