The President has taken control of the Fed. Notably, when the law was written creating the Fed, the Secretary of the Treasury was designated as the head of the Central Bank. We are returning to that era, and like it or not the Fed is being politicized.
For a long, long time, the Fed played the leading role in managing the country’s economy. Its technocrats sought to keep growth on a stable trajectory, primarily by moving a single interest rate up and down in a process insulated from the pressures of politics.
Now, though, the severity of the coronavirus crisis has placing more of the burden on President Trump and Congress. As a result, stabilization policy has been and will continue to be politicized.
Last month, the Fed took its interest-rate target to Zero, in a effort to mitigate a sharp economic downturn, and the Fed will not be raising interest rates anytime soon.
It is possible that the Fed’s target will stay near Zero throughout the 2020’s.
US economic growth had not been strong enough to generate adequate inflation even before the coronavirus, which remained below the central bank’s 2% target for most of the 2010’s.
The result, inflation expectations have decreased: Investors are betting that the Fed’s preferred measure of inflation will average less than 1% over the rest of the decade, so, the Fed will have to be very careful about raising rates.
“As long as the Fed stays pinned at the “Zero lower bound,” economic policy will work very differently. For the past 40 yrs, the central bank’s unelected technocrats have been able to fight recessions relatively free of politics, because they have focused on whether to toggle a single policy instrument – short-term interest rates up or down,” says former Fed official Narayana Kocherlakota
Now, the government will have to step in with fiscal policy that is, spending financed by sovereign borrowing. Its tools come in all shapes and sizes, and the choice among them will be highly political.
Consider the initiatives by Congress and the White House to rescue people and companies hammered by measures to contain The China Virus.
So far, the efforts have focused on large corporations. But, now there is a strong argument to provide more support for individuals.
For example, by sending out payments of $12,000 per person instead of the $1200 promised in the Cares Act. How politicians choose among such fiscal measures depends on their ideology, and that of their constituents and donors.
The Fed will have a role, though it will be more fiscal, too. Consider how Congress chose to finance emergency lines of credit to large corporations. It could have borrowed the money by issuing Treasury debt. Instead, at the behest of President Trump and Secretary Mnunchin it opted to provide a backstop to the Fed, which might end up lending as much as $4-T.
Do not be surprised to see more cooperation, in which the Fed uses its money-creating power to support Congressional fiscal policy.
Analyst like myself see this connection leading to inflationary pressures like we saw in the late 1970’s. The Gold Bugs see it too.
Now, with elected officials leading, economic policy will be subject to the dynamics of politicization and polarization that the technocrats believe have obstructed Washington’s decision-making in so many areas.
President Trump has taken control of the Fed, Wall Street and the Bauers are no longer in charge of the US economy.
Have a healthy day, Keep the Faith!