President Donald Trump could win or lose a second term in 2020, depending on what Federal Reserve Chairman Jerome Powell does to interest rates in the coming year. Hurt by losing control of the House in the midterm elections, President TrumpDonald John TrumpEx-White House counsel interviewed Whitaker about joining Trump’s legal team: report Flake slams Trump for doubting Arizona vote count: No evidence of ‘electoral corruption’ Comey talked about sensitive FBI matters on personal email: report MORE needs Powell’s cooperation even more than he did before the midterm elections.
Trump wants Powell to take his foot off the interest-rate gas pedal, which will help him win a second term. He has already begun to exert pressure. Trump gave Powell his job; it is only fair that Powell give him an easier path to a second term, according to Trump.
With the 2020 presidency at stake, members of the Federal Reserve Board (FRB) and especially Chairman Powell, should expect vigorous verbal assault and less publicly visible pressure from the White House and the Republican leaders to stop raising the discount rate, at least for a while.
The FRB is an independent body, whose chair is nominated by the president and approved by Congress. It has two related missions: to keep unemployment and inflation low. It does so by controlling the the discount rate — the rate it charges commercial banks on short-term loans.
Changes in the discount rate cause changes in interest rates on all loans, such as mortgages and credit cards balances, throughout the economy. Also, such changes affect demand for investment products, such as stocks and bonds, from American and foreign investors.
Generally, lowering the discount rate stimulates the economy by increasing business and consumer demand, which increases employment. This has been achieved by Fed rate-easing to combat the Great Recession. When this rate is raised, the growth rate tends to slow down and inflation drops.
The discount rate is a blunt, not always reliable tool, but it generally and eventually affects economic activity.
Since Powell became Fed chair on Dec. 5, 2017 the Fed increased the discount rate from 2.0 percent to 2.75 percent, with one more rate hike expected in 2018. Despite these restrictive measures, the economy grew from 2.3 percent in the fourth quarter of 2017 to an average of 3.3 percent in the first three quarters of 2018.
The unemployment rate went down from 4.1 percent in December 2017 to 3.7 percent in September 2018. This suggests that the economy had been growing faster than the gradual, 0.25-percent rate increases can thwart. Or, it suggests that the Fed actions have a very long lag time.
In view of this, a 0.25-percent rate increase is presently warranted to prevent the hot economy from overheating. If this increase does not cool down the economy sufficiently, additional rate increases in 2019 will be needed. This stance is supported by most economists.
With such a 0.25-percent rate increase, the economy would continue to grow, though at a lower rate, unemployment would stay low, and the annual interest payment on the budget deficit alone will increase by $1.7 billion annually, which will add to inflationary pressures.
Combined, these outcomes would reflect negatively on President Trump’s economic performance and could cost him his second term.
On the other hand, if the Fed refrains from rate increases, the economy would accelerate further, unemployment would go lower, interest payments on loans to finance the budget deficit and the national debt will not increase, and the stock market would celebrate, because the real cost of money would stay low.
This would reflect positively on the president’s economic performance and could win him a second term. By the time inflation caused by this refrain shows up, a second term may well be under way.
So, what’s Fed to do: Hike as suggested by the data, or refrain as demanded by the president?
Professionals like Jerome Powell and the other members of the FRB do not succumb to pressure easily, as they are guided by professional standards. They are likely to stick to their knitting of gradual rate hikes until they see clear signs of economic slowdown.
In the meantime, they should prepare for increased pressure from the White House by garnering public and political support. They must remind everyone, when making verbal and written presentations, how effective the Fed has been in lowering unemployment and keeping inflation in check, while the economy continued to grow and Americans continued to prosper.
This may not be Powell’s style, but these are unusual times.
Avraham Shama is the former dean of the College of Business at the University of Texas, The Pan-American. He is a professor emeritus at the Anderson School of Management at the University of New Mexico and his book about stagflation, “Marketing in a Slow-growth Economy,” was published by Praeger Publishing.