Fed rejects using ‘political considerations’ to set policy
The Federal Reserve was forced to reassert that “political considerations play absolutely no role” in policymaking after the former head of the New York Fed urged the central bank to consider Donald Trump’s re-election prospects in setting rates.
A spokeswoman for the Fed’s board of governors told the Financial Times that the central bank’s rate-setting body rejected the suggestion by Bill Dudley, who also served as the Fed’s vice-chairman. Mr Dudley also wrote that they should “refuse” to dole out stimulus to cushion the damaging effects of Mr Trump’s trade war.
“The Federal Reserve’s policy decisions are guided solely by its congressional mandate to maintain price stability and maximum employment,” the spokeswoman said. “Political considerations play absolutely no role.”
The rare rejection of a former official’s public statements came after Mr Dudley wrote a column for Bloomberg on Tuesday saying that providing additional stimulus would encourage Mr Trump’s aggressive trade policies, doing long-term damage to the US economy.
He also urged officials to consider how their decisions could affect the outcome of next year’s presidential election.
There is no official policy on communications for former Fed governors or presidents. Generally, they comment on the state of the economy but avoid discussing the Fed’s mandate. “It’s unlikely he speaks for the Fed”, a former Fed official said.
The comments from Mr Dudley come just days after the annual central banker gathering at Jackson Hole, Wyoming, where Fed chairman Jay Powell raised concerns about how the Fed responds to uncertainty around the trade war.
“Trump’s re-election arguably presents a threat to the US and global economy, to the Fed’s independence and its ability to achieve its employment and inflation objectives,” Mr Dudley wrote in his column.
“If the goal of monetary policy is to achieve the best long-term economic outcome, then Fed officials should consider how their decisions will affect the political outcome in 2020,” he concluded.
Ebrahim Rahbari, chief G10 currency strategist at Citigroup, said the resilience of the US economy and the Fed’s ability to react is something that allows Mr Trump greater freedom in making policy decisions that, in principle, pose risks to the US economy.
“Monetary policy is not the answer to trade policy issues. It is a very crude way of dealing with the uncertainty,” he said.
Mr Dudley said conventional wisdom suggests that if the trade war with China harms the US economic outlook, the Fed should respond by easing monetary policy. Such a response may prove ineffectual, or may make matters worse, “if the Fed’s accommodation encourages the president to escalate the trade war further, increasing the risk of a recession”.
Mr Powell had said at Jackson Hole that factoring trade uncertainty into the central bank’s policy framework was a “new challenge”, acknowledging the Fed’s hands were tied in its ability to influence international trade negotiations.
Mr Dudley suggested that officials could take this line further and “state explicitly that the central bank won’t bail out an administration that keeps making bad choices on trade policy, making it abundantly clear that Trump will own the consequences of his actions”.
This, he said, would benefit the Fed and the economy by discouraging a further escalation of the trade war, reassert the central bank’s independence by putting distance between itself and White House policies and allow the Fed to save its policy tools when interest rates are already at low levels by historical standards.
Traders are currently pricing in a 94 per cent chance the Fed will cut its benchmark interest rate by 25 basis points at its upcoming meeting in September, with the odds of a more aggressive 50 basis point cut much smaller, at 6 per cent. Following Mr Powell’s speech at the Fed’s annual meeting in Jackson Hole on Friday and Mr Trump’s threat of fresh tariffs on China, the probability was as high as 17 per cent.
Should Mr Powell proceed with a quarter-point cut in less than a month’s time, markets are pricing at least another three cuts by the end of next year.