MNI INTERVIEW: Trump Attacks Undermine Case For Fed Cuts-Tracy

President Donald Trump’s attacks on the Federal Reserve erode its credibility and could mean that rate cuts actually push up government financing costs, former senior Fed economist Joseph Tracy told MNI.  

If the Fed cuts in September as expected and signals its intention for still lower rates, then "it's quite possible that instead of seeing the 10-year Treasury yield come down, it may go up," making it more expensive for businesses to borrow, Tracy said in an interview. 

"Even if the Fed really thought it was worth trying to support the economy by lowering rates, it’s not going to work because people will interpret that not as a careful weighing of risks but as acquiescing to administration pressure,” he said, adding that a loss of Fed credibility would ultimately limit the degree to which interest rates can be reduced even in the face of temporary price pressures.

"Paradoxically, the administration's pressure campaign has removed the normal amount of flexibility when the Fed is facing supply shocks." 

The long end of the yield curve is rising as inflation expectations shift upward and investors demand a higher term premium in light of a more uncertain future for interest rates, said Tracy. But, faced with the "formidable challenge" of keeping inflation expectations anchored at 2%, the Fed will need to prioritize its inflation objective, much like Paul Volcker did in 1981, he said. 

"Even though it’s a dual mandate, in the long term, having low and stable inflation is Job One because that makes sustainable growth possible." 

While the Fed could potentially attempt yield curve control, promising to buy bonds at any price to cap yields, this would only help marginally, and at the enormous cost of chasing away private investors and blowing up the Fed's balance sheet, said Tracy, who was senior advisor to the Dallas Fed president and is currently a distinguished fellow at Purdue University’s Daniels School of Business and a non-resident senior fellow at the American Enterprise Institute.

INDEPENDENCE SAFEGUARD

With White House economist Stephen Miran set to be confirmed to a governor’s seat and the attempt to fire Governor Lisa Cook in court, Trump may soon have a majority on the seven-seat Fed Board. 

However, Tracy pointed to one unusual route by which the FOMC could defend its independence. Every January, the FOMC elects its chair and vice chair for the year. In the past, these have always been the chair of the Fed Board and the president of the New York Fed. However, should Chair Jerome Powell choose to serve out his remaining term as governor, the FOMC could elect him as chair, Tracy said. 

"If they were very concerned about the apolitical nature of the Fed's being changed, they could vote Jay in next year and do it again the year after," he said. 

POLICY NOT TOO RESTRICTIVE

Monetary policy appears to be well calibrated for the current state of the economy, Tracy said. Had policy been too restrictive, inflation would have trended down this year instead of being stuck at 2.6%-2.7%, he said.

It's too early to say exactly how consumers, retailers and suppliers will split the cost of tariffs, but it's likely that consumers will end up paying for more than half the rise in costs, he added. (See MNI INTERVIEW: Fed To Cut Faster After Weaker Jobs - English)

The biggest threat to the future of the U.S. economy is Congress's spending problem, Tracy said, pointing to the UK and France as examples of the dangers of persistent deficits.

"The U.S. should take it as a bit of a warning sign."