Back in May, I wrote about President Trump’s failure to assert control over the Federal Reserve and the monetary policy it makes. Trump declared the Fed should cut short-term interest rates by half a point at its May meeting; the Fed ignored him, keeping rates unchanged. The Senate, too, ignored his stated desire to appoint two political cronies to the Federal Reserve Board.
Now, a month later, members of the Fed Board are talking openly about the possibility of rate cuts. Their comments have, in a way, been precipitated by the president’s actions. So maybe the president does have a lot of sway over the Fed after all. But it’s not the kind of sway that’s very useful to him.
Let me explain.
While the Fed has taken pains to publicly ignore the president’s comments about monetary policy, it is quite responsive to the financial markets. When stock prices and long-term interest rates fall, that can be a sign of a worsening economic outlook. A worsening economic outlook can be a reason for the Fed to cut rates; lower rates make it easier for businesses and consumers to borrow and invest, and can therefore prop up economic output when other drivers of the economy are weak. And the Fed particularly wants to ensure that the markets know that if the economic outlook does worsen, it will respond appropriately, with rate cuts.
So, one way the president can get Fed officials to talk more about the possibility of rate cuts is by doing things that cause the stock market to fall. If he pushes stock prices down enough, he might get them to actually cut rates.
And indeed, since Trump’s proposed Fed appointments were rebuffed, he’s escalated the trade war with China and declared his intention to start one with Mexico; stocks have puked, with the Dow Jones Industrial Average falling about 7 percent from May 3’s high to yesterday’s low; and now, Federal Reserve officials have made statements that they may cut rates if economic conditions warrant, leading to a significant rebound in stocks today.
The problem with this method of influencing the Fed is it requires doing things that cause stock prices to fall. Those things are presumably damaging to the economy, or at least the corporate profits component of the economy; otherwise, they wouldn’t cause stock prices to fall. Those negative effects — for example, a reduction in business investment caused by added costs and lost access to foreign markets due to tariffs — act to offset the positive economic effects of lower interest rates, or of the expectation of lower interest rates.
Also, to the extent the Fed succeeds in reassuring market participants through statements about what it will do if the economy softens, it may not actually need to cut rates at all.
It’s the Fed’s job to react to economic conditions, promoting full employment and stable inflation even when outside factors could throw either of those targets off course. Such outside factors include the president’s threatened and actual public policies. But the president’s approach is not likely to produce the sort of economic juicing he clearly wants out of the Fed — they’re only poised to do what they can to unwind whatever damage he causes.