The Clash between Trump and the Federal Reserve

Samuel Rines

Economics, Americas

Trump's rhetoric has put the central bank in a difficult situation.

When it comes to the Federal Reserve, often called the Fed, President Trump is not a fan. Despite appointing the current Chair of the Federal Reserve, Jerome Powell, the President has consistently expressed his displeasure in the Fed continuing to raise interest rates. But recent the critiques went a bit further with reports of the President thinking about firing Powell.  While the legality of such an action can be debated, it cannot be overstated how disastrous that action would be to the U.S. financial markets and Main Street. Moreover, the President’s attacks on the Fed may have consequences regardless of whether a firing occurs.

There are the certain and obvious consequences of a firing for the financial markets. Money managers would not look kindly on a Fed whose policy was being controlled so obliquely, and asset prices would assuredly decline. Perhaps more worrisome is that asset prices would be unlikely to materially recover for a while, and it is this prolonged period of asset price depression—not that it would happen for certain—that should raise concern.

There are two primary reasons asset prices would stay lower for longer. The first is a lack of confidence in the independence of the Federal Reserve. The firing (or demotion) of the Chair Powell would directly call into question whether the Fed was independent. Central Bank independence is critical for policymaking and markets trusting that policymaking. Regardless of who was appointed to take Powell’s place, it would take years to undo the damage done to the credibility of the Federal Reserve’s monetary policy.

The second reason asset prices would remain under pressure is the loose policy path that would be taken. Ostensibly, the firing of Powell would be due to the decision to raise interest rates. And the task of anyone nominated in his place would be to undo the perceived damage to the economy. Oddly, markets would welcome a pause in rate increases (and are likely to get one in the first half of 2019) but would fret if cuts came from a new Fed chair or as a response to turmoil following Powell’s dismissal. The signal would be not be perceived as related to the U.S. economic outlook or the dual mandate and more about the election cycle.