Money Matters

Sovereign Fed has never been more crucial

June 19, 2017
By Web Desk

This week, the Federal Reserve, as expected, raised interest rates by a quarter of a percentage point. The move was most likely mistaken - there is precious little sign of wage or price inflation, which have both consistently undershot expectations - but a 25 basis-point move here or there is unlikely to be disastrous.

Of more interest for the Fed’s long-term future is the question of its leadership and political independence. Donald Trump, who inveighed against the Fed in general and its chair Janet Yellen in particular during the election campaign, has since appeared to swing back and forth on whether he approves of her performance. Ms Yellen’s term as chair is up early next year, and her reappointment is highly uncertain.

Although Ms Yellen deserves another term, assuming she wants one, the threats to the Fed go much wider. The central bank has been consistently under attack in recent years, particularly from congressional Republicans, for its super-loose monetary policy. The White House should be defending the Fed’s political independence, removing any suspicion that it might be setting monetary policy with a view to currying political favour.

Few good deeds in Washington go unpunished, and the Fed’s exemplary activism in the aftermath of the global financial crisis brought down much ill-informed opprobrium on its head. It was laughably accused of risking hyperinflation through its quantitative easing programme and by holding interest rates low. Mr Trump joined in this chorus last autumn, when he charged the Fed with holding rates down for political reasons.

This is nonsense. Ms Yellen’s Fed has, correctly, largely kept in place the philosophy of Ben Bernanke, her predecessor. It has been prepared to use all tools at its disposal - including its balance sheet - to prevent corrosive deflation, and to exercise caution about tightening. The idea that it is taking risks by erring on the side of loose policy is wrong. The Fed has delivered consistent growth and positive, if still too low, inflation.

As it happens, Mr Trump has suppressed his criticism of Ms Yellen since the election. He has perhaps realised that low interest rates are helpful to his aim of boosting economic growth, especially as his promised fiscal stimulus looks unlikely to happen on any serious scale any time soon. The president should go further, both reappointing Ms Yellen and making it clear he will not repeat his earlier criticism of the Fed nor support it from Congress.

Although presidents have generally chosen policymakers affiliated to their own political party when the position of Fed chair becomes vacant, there is a tradition of reappointing competent incumbents when their terms come up for renewal. Paul Volcker was initially selected by Jimmy Carter and then reappointed by Ronald Reagan; Alan Greenspan was chosen by Mr Reagan and reinstalled by Bill Clinton, Ben Bernanke picked by George W Bush and kept in place by Barack Obama.

Continual political pressure on a central bank can damage its credibility even if its policymakers do not alter their actions in response. It is hard to set policy dispassionately while being aware that too radical a change might result in threats to the institution’s independence. Mr Trump should reappoint Ms Yellen. Failing that, he should pick a respected economist who approves of the Fed’s philosophy over the past decade and intends to continue it. The president should then respect the independence of the Fed, desist from criticising it and discourage others from doing so. To do otherwise is to imperil the US economy.