The Real Reason Politicians and the Fed Disagree

Federal Reserve

Presidents have been at odds with the policies of the Federal Reserve before, but Donald Trump has taken this to a whole new level, as he often does with things.

The goals of the Federal Reserve Bank of the United States are clearly specified in the Federal Reserve Act. They are to promote maximum employment and stable prices. These are their only two goals.

This does not include helping politicians get elected, promoting rises or even stability with stock markets, or even promoting economic growth beyond what is necessary to achieve their two goals.

Economic growth is actually a neutral criterion here because we can often have too little or not enough of it and have our growth be too strong or too weak will matter. Too weak and this may impact employment. Too much and this will interfere with the goal of stabilizing prices, in other words, inflation.

This does not mean that the Fed will always execute their mandate perfectly or even very well at times, but this is what they are supposed to do, and we may then use its mandate as a benchmark for judging its performance.

Whether or not their views are popular with politicians, the American public, or anyone isn’t even material to the discussion though. If everyone understood what they are looking to achieve and why they do what they do, there wouldn’t be much of a gap at all between presidents or the public and the Fed, but the gap is actually a pretty big one and its size is behind whatever disagreements that emerge.

President Trump, for instance, has a preference for more expansionism, but the problem with too much of it is that it expands prices too much and causes too much inflation. If we think that this is a desirable pursuit, this indicates clearly our lack of understanding of economics, but few people really understand it even at the basic level that is required to understand why the Fed is supposed to do what it does and why this needs to be done properly.

Bill Dudley, former president of the New York Fed, has recently spoke out about the rift between the executive and the central bank. He actually sees one of the major roles of the Fed as acting in opposition to decisions made by the executive, the President in other words, and while this isn’t really one of their roles, in practice it might seem to be one.

He feels strongly that the Fed should not “enable” the policies of President Trump, which he believes will lead to “economic disaster.” He is speaking here about Trump’s using tariffs as a weapon, and while the Fed would never work to enable such a thing, they certainly would take counter-measures to limit the damage.

This is not a bad thing though and actually serves to minimize the effect of the policies. An example would be to cut rates in order to cushion the economic blow of these tariffs, which do serve to contract the economy due to their being a means of taxation.

We cannot stand by idly and watch this happen, if we can take action to help, because if this gets too out of hand, employment numbers will go down and that’s part of the Fed’s mandate as well as an extremely important part of our overall economy. It’s not a lack of growth in itself that ever really does us in, it’s lack of employment more than anything.

This is All About Balancing Things Properly

The Fed therefore performs a balancing act between stimulating employment and restraining inflation, and given that we now have both extremely low unemployment and very low inflation, this is perhaps as close to the ideal as we could ever get.

For all Trump’s boasting about how much he has helped the economy during his tenure as president, and his cajoling the Fed to do more to expand it further, his actions with all the tariffs that he has hit his electorate with runs completely counter to this. These tariffs are harmful to the American economy in no uncertain terms, and these are not actions that can go completely unanswered.

The nature of our government will place certain powers in the hands of those who may not be fully competent or even competent at all to exercise. However, the American system of government has checks and balances to look to restrain this power when deemed appropriate. We cannot hand over the keys to the Fed to the president or Congress because we would lose what control we have, and we do not want that.

Congress can pass whatever laws it wishes, for instance, but this power is limited by the Constitution and the judicial branch will step in when needed to put the brakes on lawmakers when they go too far. The same happens to some degree with economic policies, where the Fed can take corrective action when policies do not correspond well enough with overall economic goals.

The judiciary and the Federal Reserve must therefore be afforded independence of action, and this is a very important element in the process because it ensures that the economy won’t be overly subject to the whims of the people, Congress, or the president, where their decisions may have derogatory effects upon our well-being.

The mandate of the central bank is therefore to use our money supply to do their best to achieve the important goals that they are assigned, goals that we should not be at odds with.

Most people understand the importance of low unemployment, but they tend to struggle a lot more with the price stability side of things, and this is because this requires at least a basic understanding of why keeping inflation in check matters.

This is not a matter of choosing the present over the future like overspending causes, and we already take that road to an extreme enough degree that our actions will eventually bring down the world economy and throw us into an economic wasteland, but inflation messes us up in the present as well as the future.

The Fed is quite open these days to doing whatever it can to prevent too much economic slowdown, regardless of the cause, including decisions by President Trump that do real harm. Dudley believes that they should restrain themselves from trying to help, and let Trump feel the unadjusted impact of the error of his ways, but that would be very foolish.

The Fed has to take appropriate action to achieve its mandate the best way that it can, and in doing so, they do serve as a balance to the body checks that Trump is laying upon his people. There isn’t any legitimate room to ever question this requirement, even though some may find pleasure in seeing the man pay the political price that he may deserve.

Dudley goes as far as to advise the Fed to make Trump’s being ousted at the polls in 2020 a prime objective, which is a bizarre twist on politicians believing that it is appropriate to seek to interfere with the Fed. He wants these tables turned, which is way outside their purview.

This would require that the Fed allow the economy to deteriorate on purpose to seek to punish Donald Trump and help contribute to his demise. The chances of this actually happening are zero though and we may also be thankful that Dudley isn’t an active member of the Fed anymore.

More Understanding About Inflation is the Key

All the disagreements between presidents and the Fed result from a lack of understanding of the role of inflation among the population, the people who vote for these presidents. If people did understand how bad inflation is, and a president raised it too much to look to please them, this just wouldn’t work unless they are also fooled by this.

We teach our kids a lot of different things, and many do question the practical value of at least some of these things, but having a better understanding of basic economics, and in particular, how what our government does helps or hurts this goal, would go a long way. The gap in understanding between the Fed and the people in general, including presidents, is the real problem here.

Inflation devalues both our income and our savings, and what inflation means is that the purchasing power of a given amount of money gets reduced by the rate of inflation. This purchasing power just doesn’t involve our income, although real income goes down, it also devalues all money, including everything we have saved and the money we have invested in our future.

This is a big deal indeed and something that rarely is given its due in the media, and the media is the new church these days, where we get just about all of our “knowledge” from. We can’t really be blamed for not understanding the evils of inflation very well, because we haven’t been taught to and this is not knowledge that we are born with.

This wouldn’t be that hard to at least improve to a reasonable level though, and it starts with making inflation more transparent. If we had people add their income to their net worth and then multiply by the inflation rate and come to realize how much money this has cost them, they at least would be able to better realize the true costs to them.

We can also use this in a macro sense and figure out how much the economy as a whole has lost, and this is a lot bigger number than multiplying it against GDP. We are talking about almost a trillion dollars lost for every percentage point of inflation, so if it is 2%, we have lost two trillion.

When the numbers get this big, it isn’t always easy to fathom, but 2 trillion dollars’ loss on a per capita basis means over $5000 a head per year, and this is $25,000 lost for a family of five. By the way, this is a historically low loss, as we’ve been fortunate to enjoy very low inflation rates over the last few years.

Full percentage points are big numbers when it comes to inflation, and we really need to use tenths of a percentage to bring this closer to actual decision making. For every tenth of a percentage, everyone loses $500, and that adds up to real money given that we can vary quite a few tenths at times.

We actually have to pay a certain price here, to promote the Fed’s other goal, employment. If inflation is too low, and especially if we have deflation, unemployment will rise. We do need an economy that is vibrant enough to keep things humming employment wise. We need to build in a buffer between zero inflation and our targets, because if inflation were zero and we made a mistake we would send it below zero, which is not what we want, so the couple of percent that we build in serves as a margin of safety in addition to making a modest contribution to employment.

If we get that inflation over this mark is bad, and we understand why it is bad and what it costs us, we won’t be so eager to put our fists up or be anything but pleased when the Fed acts to control inflation, and be upset if it still manages to rise higher than we should want.

The Fed deserves an A for its efforts of late, when we look at the situation with understanding. Someone needs to understand though, and we should actually be very grateful that they are at the helm and not Donald Trump, who very likely would drive us way too far into the ground if he actually had this power.

Ken Stephens

Chief Editor, MarketReview.com

Ken has a way of making even the most complex of ideas in finance simple enough to understand by all and looks to take every topic to a higher level.