There is nothing the Federal Reserve values more highly than its independence.
The Fed may frequently be confused about the state of the economy. They rely on models that are clearly deficient and do not correspond to reality. The Fed is usually late to the party — raising rates after inflation has taken off and cutting rates when the economy has already entered a recession. Despite these and many other blunders, the Fed knows that they have independence from political interference in their decision making.
In truth, there’s less to this independence story than meets the eye. In the late 1940s and early 1950s, the Fed followed White House and Treasury orders in keeping rates low to help finance the war effort in World War II and the Korean War. In the early 1970s, the Fed accommodated President Nixon by keeping rates low to help his 1972 reelection effort (this led to rising inflation in the mid-1970s and borderline hyperinflation in the late 1970s).
Still, despite these and many other examples of a politicized Fed, the mantra of independence is chanted repeatedly by all Fed chairs as a way of keeping politicians at bay. But the Fed is not independent of the economy.
They must respond to economic booms and busts and adjust policy to achieve their dual mandate of price stability and low unemployment. What happens when Fed policy based on the economy seems to help one political party over the other? That’s exactly the dilemma described in this article.
Preeminent economists Carmen Reinhart and Vincent Reinhart point out that the Fed may need to keep cutting rates and expand the money supply in order to fight an economic slowdown and avoid a U.S. recession. But those same policies will boost stock prices and greatly help Trump’s reelection chances.
The Fed is trying its best to help the U.S. economy and also maintain its independence. Still, its policies are a definite benefit to Donald Trump’s campaign. This just goes to show that “independence” is in the eye of the beholder and politics and money are deeply intertwined, whether central bankers like it or not.
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