When is the Federal Reserve an Enabler?
In two major period over the past fifty years the Federal Reserve has been the great enabler, using low interest rates to temporarily juice the economy, assuaging the President and aggressive interests in Congress and at times the financial services industry. The first time was in the 1970’s; the culprit was Fed Chairman Arthur Burns who capitulated to Democrats and Republicans alike in keeping interest rates lower than advisable and sparking the Great Inflation, only brought under control in the very early 80’s through the intentional imposition of what at the time was the worst recession in the USA since the Great Depression.
The second time was under Fed Chairman Alan Greenspan who repeatedly from 1995 to 2006 intervened to prop up low stock prices or protect against alleged systemic events. But Greenspan did not try to lift asset prices to forestall depression, as Bernake, Yellin and many of their counterparts at other central banks elsewhere did after 2007. He did it to protect rates of return, to buoy Wall Street, the so called Greenspan put. Ultimately, his excessive generosity was a major contributing factor in a greater recession than the 1979–81 two-year downturn; the 10-year 2007–2017 Great Recession surpassed it and became by far the worst downturn since the Great Depression.
Arthur Burns and Alan Greenspan — albeit in different ways — each priced credit too low, spurring excessive risk taking, generating price inflation in the first case, asset price inflation in the second. The other major Fed chairman of the post 1979-era — Volker, Bernake and Yellin — each spent their tenures cleaning up the mess caused by their immediate or distant predecessors. Their monetary policies were corrective; no one knows that they would have done in the absence of the extremely difficult economic conditions caused by their forerunners.
This bring us to Chairman Jerome Powell. He was appointed at the tail end, some would say after the end of the Great Recession. By most major measures, the USA is no longer in the grip of the Great Recession. Asset prices have rebounded, unemployment is low, wages growing, if gingerly, GDP growth modestly exceeds recent historic performance. Nonetheless, some imbalances are growing. Federal debt and consumer debt is up; the world trade system threatened. Why reduce interest rates now?
Are we starting a third round of Fed enabling? The recent Fed rate cut, the first since 2008, was dubbed by Mr. Powell as “mid-cycle adjustment,” implying that it may not (or may) be the start of a new cycle of interest rate cuts. The cut comes at a particularly opportune time for President Trump who aggressively lobbied for it.
An obliging Fed enables Mr. Trump to stall if not prevent some adverse consequences of his reckless trade policy. Lower interest rates help indebted farmers piling up debt as Chinese markets disappear. Downward pressure — unsustainable pressure — on consumer debt is very handy when higher prices appear for basic consumer staples. As the stimulus from the Trump tax cuts fade, and wary-Trump-war-weary businesses stall or cut back on investment, it is particularly important for Trump to keep consumer demand high, to buoy it with low interest rates. However, a corrective slow down, or even recession now, may help rebalance the economy for faster growth later.
Recessions and slow downs play a role in economic well: by purging the systems of imbalances such as excessive consumption and debt, or misguided investments, slow downs cleanse an economy. Imbalances build up in the system — in this case, growing government, consumer and low quality corporate debt — that will one day have to be moderated to insure financial solvency. This moderation may induce a slow down or even a recession. Should this day, which will ultimately come, be pushed further away while simultaneously made more severe, merely to rescue a president pursuing reckless trade and spending policies?
Similar argument against politically helpful Fed interventions have been made many times in the past — by conservatives protesting government stimulus in downturns, and by liberals protesting government rescues of irresponsible lending by banks and other financial institutions. Indeed, someone of some political persuasion will invariably consider any Fed interest rate cut at any time in any circumstance to be an act of enabling some economic evil, and a form of “enabling” an economic neurosis. However, it is a fallacy, a dangerous one, to assume that all Fed intervention is ultimately really political, the the Fed’s independence is an illusion.
The point is that there is a right Fed policy and a wrong one. The right Fed policy guards the economy against severely adverse consequences balacning employment and inflation considerations while fundamentally trying to keep the system of reward and punishment and even of recession and growth in effect, in balance. At times the Fed needs to engineer a recession, to cause one, as it did in 1980, in order to prevent even more serious adversity in the future.
So the question for Mr. Powell is: what is balance? What protects the economy to the extent necessary but not so much that fundamental corrective processes are ignored and they ignite later and cause more damage than they otherwise would have. Mr. Trump’s increases in Federal deficits are pointless. They do not support infrastructure spending which might spur long term growth; they do not lead to much lower consumer debt, as they were aimed largely at an audience that has little of it; they did not spur business investment? They are not temporary imbalances that offset a greater evil: they are the evil.
Why is it essential for the Fed to control inflation because it will ultimately result in recession and loss of output but it is not essential to control the imbalances in consumption, government debt, and foregone revenues and higher costs that result from Mr. Trump’s economic and trade policies but the effects of which are postponed by unreasonably low interest rates?
Inflation in the 1970’s and investment bubbles in the 1990’s and 2000’s ultimately had the same impact as Mr. Trump’s policies. They temporarily boosted output and left the ensuing problems, and recessions, to be dealt with a little further in the future. The mistakes of excessively loose Fed interest rate policies in these eras is now clearly seen; Mr. Greenspan is now seen by many as the enabler he was while Arthur Burns, the Fed Chairman and one of the architects of that eras high inflation is similarly seen in an unappealing light. Low interest rates had a strong policy rationale after the near world economy collapse in 2008 but the case is much much weaker now. When is Mr. Powell following the Fed’s “mandate” to seek full employment as well as to control inflation and when is he indeed an enabler? He seems to be flirting with an undistinguished legacy.