As President Trump this week increased his already-loud complaints lambasting the Fed, opinion has coalesced on two sides of the monetary-policy debate. Trump allies argue, not always without reason, that the U.S. central bank needs to be knocked off its pedestal, at least a bit. Fed fans counter not only that the Fed must remain an independent arbiter of macroeconomic triggers, but also that the White House can do little damage to the central bank’s bastion. Fed fans are wrong on the second count – although the Fed should surely be independent of political whim, its policies have exacerbated economic inequality and thus sparked much of this political backlash. And, because this backlash is so ferocious, the Fed is far from the invulnerable fortress many believe. This is a time of unique political vulnerability for the Federal Reserve, no matter how hard it tries to dismiss nay-sayers up to and including the President.
Think this is alarmist? It could well be, but we’ve repeatedly seen conventional wisdom discount the potential for radical policy realignment under President Trump only to watch a totally new policy direction emerge from the combined force of Presidential tweets, accommodating or even enthusiastic advisers, and a strongly supportive House GOP. Think trade wars – we’ve got one in full swing even though conventional wisdom at each twist and turn assured the public that it couldn’t possibly happen. Taking on the Fed has even greater potential political appeal with Mr. Trump’s base because, in sharp contrast to a trade war, it doesn’t cost anyone anything – at least not for a while.
The Fed’s fate is far more tenuous than many believe for two reasons. First, America has never really cottoned to central banks. That’s why it took us so long to have one and why – see below – the Federal Reserve lacks much of the political invincibility and sweeping powers conferred on other central banks. Federal Reserve “accountability” has been a demand since the 1913 Federal Reserve Act institutionalized a lot of it in the Fed’s charter. Over the decades since, Republicans and Democrats have differed in what they consider accountability, but populists on each side of the aisle nonetheless swear by it. If President Trump were ever to launch a substantive attack on the Federal Reserve, he would find a lot of friends, many of them Democrats.
Second, the Fed is a “creature of Congress,” as Fed officials demurely acknowledge whenever most aggressively challenged by Congressional critics. The central bank’s ability to mobilize moneyed interests to its defense and thus to deflect its most demanding critics is legion, but not secure. The clearest evidence of growing fragility is the increasing number of raids on the Fed’s budget to fund federal spending as deficits rise. So far, Congress has only nibbled at the edges of the Fed’s billions, but a Trump Administration-led effort to recapture IOER directly for Treasury or dig deeply into the Fed’s earnings could prove potent if the next Congress becomes as populist as midterm projections suggest.
I doubt that other core elements of the Hensarling-Barr Fed agenda will have similar traction next year. For example, longstanding efforts to mandate the “Taylor Rule” lack the bipartisan appeal of just taking more than a few billion from “bankers” to fund constituent spending. Efforts to limit the Fed to an anti-inflation mission will run hard into Democratic demands that the central bank instead maximize employment far more emphatically than they believe it has done to date. “Audit the Fed” efforts are also such a long-tried, long-failed libertarian goal that new proposals are unlikely to do any better than before.
What might progressive Democrats demand beyond far more focus on employment? Sen. Warren (D-MA) is toying with a proposal to make the Fed the nation’s retail banker. Given that an initiative along these lines got serious consideration in Switzerland, think what an angry electorate might demand here. Senate Banking’s Ranking Member, Sherrod Brown (D-OH), has an enthusiastic list of complaints about both monetary and regulatory policy, with Ranking Member Waters (D-CA) on Financial Services sure to pick up where Henry Gonzalez, a progressive House Banking chairman thirty years ago, left off in his quest to make the Fed more accountable, diverse, less reliant on Reserve Banks, and far more demanding of the largest U.S. and foreign banks.
What could make a difference in a populist Congress under an angry president and a changing team of economic advisers? Situational thinking seems to be the order of the day in this White House and forecasts thus depend on where markets go and the economy beneath them takes us. However, a scenario in which markets drop, rates rise, and Treasury-borrowing costs skyrocket is uniquely problematic for a central bank viewed by friends in high places with increasing disrespect and distrust. Could President Trump lead Congress in anti-Fed directions or happily follow it there? I doubt it, but sanguine assumptions about Fed invulnerability are dangerous in volatile times at the top of the business cycle with trade wars and deficits sure to put the White House on the defensive and a Congress out as always for itself.