Harsh rhetoric from President Donald Trump to Federal Reserve Chairman Jerome Powell regarding interest rates and the state of the economy. The banter between the two has been rather one-sided, with the President hitting Twitter, and Powell staying relatively under the radar with comment.
The Fed will be sticking to its plans to continue gradual rate hikes, according to the minutes of the September FOMC meeting. The central bank hiked short-term rates during the meeting, the third increase of 2018. Officials have steadily lifted rates since 2015 as they seek to move to what they believe will be a neutral environment for the short-term rate, pegged now at abou t 3 percent.
President Trump has expressed dismay largely in part to what is perceived as a low-inflation environment. “My biggest threat is the Fed because the Fed is raising rates too fast,” Trump remarked. “You look at the latest inflation numbers, they’re very low.”
Higher rates can impact consumers by increasing borrowing costs, which have already ticked higher. Auto loan rates are at a nine-year high, and 30-year fixed mortgage rates recently climbed to their highest level in seven years. In theory, this is how it is supposed to work. The Fed’s interest rate increases make it more expensive for businesses and companies to borrow money from banks. This decreases the amount of capital flowing around the financial system and eventually curtails economic growth. Interest rate hikes are also thought to curtail price increases and prevent runaway inflation.
One cannot argue with Trump that inflation is not an issue now. However, inflation may no longer be the best indicator of whether the economy is overheating, Powell said in an August 24th speech. The Fed doesn’t have a mandate to prevent an unsustainable surge in stock prices, as occurred before the 2001 recession, or of homes, as happened before the devastating downturn of 2007-09. Powell states, “In the run-up to the past two recessions, destabilizing excesses appeared mainly in financial markets rather than in inflation. Thus, risk management suggests looking beyond inflation for signs of excesses.”
Predicting these asset bubbles is tough. Very tough. With that said, perhaps the best you can do is manage the collateral damage once it has occurred. This is the thought process perhaps being used by Powell. He appears more inclined than previous Fed chairs to consider employing interest rates when faced with potential financial imbalances. The monetary modeling is far from a science in its cause and effect predictability. There is no real consensus among economists today as to which indications foreshadow a slowdown or growth period. Fed board colleague Jeremy Stein says, “Monetary policy should pay attention to indicators of financial market stability or excess, however the macro-prudential regulatory arsenal is pretty non-existent.”
Economists are focusing on the asset bubbles of late to look for clues in future moves of the economy. Powell senior special adviser Jon Faust echoes the sentiment of the difficulty of this task. “Despite a new openness to the idea of asset-market excesses in some parts of the economics profession, the profession is nowhere close to agreeing on a new dogma.” While ostensibly independent, the Fed and chairman Powell have the unenviable task of maintaining a balance between what they believe is correct and what President Trump will tweet.