The President and The Fed
In recent weeks, President Trump has lashed out at the Federal Reserve for raising rates too quickly and bringing volatility to equity and bond markets.
Following a round of volatility in the equity and bond markets in early October, President Trump lashed out at the Federal Reserve for raising interest rates “too fast” and being “out of control”; even going so far as labeling the central bank as his “biggest threat”. While these attacks may feel misplaced to some, it is far from the first time a sitting president has been at odds with the quasi-independent Federal Reserve. Presidents have often felt pressured to maintain a strong stock market and a hot economy and have turned to the Fed for assistance. However, the Fed was designed to overlook these short-term political pressures and focus on the longer-term and broader-economic picture. While presidents and fed chairs typically steer clear of one another’s territory, a famous breakdown occurred in the run-up to the 1972 presidential election, when President Nixon repeatedly pressured then-Fed Chairman Arthur Burns to boost the economy. In what appears to have been a failure of independence, the Fed lowered rates. While this stimulated the economy in the short-run, it led to a recession and a decade of crippling inflation.
Why is the Fed Raising Rates?
The Federal Reserve is tasked by Congress with a dual mandate of maximizing employment and maintaining stable prices. While there are multiple tools at the Fed’s disposal, the primary mechanism to achieve the mandate is the raising and lowering of the federal funds rate. When the Fed wants to stimulate the economy, it lowers the rate, and when it wants to slow the economy, it raises the rate.
In September, the Federal Reserve increased the target range for the federal funds rate .25 percent, to 2.00 – 2.25 percent. This was the third time the Fed raised rates this year and the eighth time since 2015. The Fed has been systematically raising rates in an attempt to keep the economy growing while at the same time reigning in inflationary pressures. With unemployment below “full employment” at 3.7 percent and inflation converging on the Fed’s 2 percent target, the central bank is now moving away from an “accommodative” interest rate policy to a more neutral stance – one that neither boosts, nor slows the economy. While this may be good for the economy in the long-run, it has created volatility in the markets and caused friction with the White House. If the Fed get its policy right, however, the markets should stabilize as they adjust to the new interest rate environment and investors regain their confidence.