President Donald Trump and the Federal Reserve Board (Fed) Chairman Jay Powell have renewed their ongoing battle over monetary policy. Despite the Fed’s recent and strenuous efforts to support the economy’s recovery through monetary ease, the White House wants more. The Fed’s decision to bring short-term interest rates down to just about zero does not, according to the president, go far enough. Trump wants interest rates pushed down into negative territory. The country, he says, deserves the “gift” of negative rates. Chairman Powell has resisted, probably for good, long-term economic reasons, but there is no telling how the battle will turn out, since it will turn more on politics than on economics and especially on how fast the optics on the economy improve.
Trump’s motivations in this dispute are clear enough. In this regard, he is no different from any other president before him. With the election approaching, he wants to generate immediate and impressive economic growth and do so at just about any cost. As with other presidents at comparable points in their administrations, he has a hard time seeing past the first Tuesday after the first Monday in November. (George Washington may be an exception to this rule, but if so, he is the only one.) By the White House’s lights, matters demand prompt and dramatic economic stimulus on every front and regardless of any post-election consideration. This is especially true for Donald Trump, who will have to carry the lingering economic effects of the pandemic into his campaign.
The Fed, however, has an entirely different perspective, and it should, since its charter insists that it take a non-political, longer-term view. Well aware of the need for stimulus to bring the economy back after re-opening, Chairman Powell and the rest of the Fed Board are also bound to consider the effects of negative rates beyond their perhaps immediate ability to spur economic activity. For one, Fed governors can see from foreign experience that negative interest rates more times than not have failed to generate much lasting economic response. For anther, there is reason to worry that negative rates distort financial decision-making because their unusual nature can confuse the rules of thumb and formal algorithms often used by traders and investors. The Fed’s governors worry as well that the introduction of negative rates now will strain bank finances, especially since the anti-virus quarantines and lockdowns have raised the risks of defaults and bankruptcies. On this score, it is not that the Fed wants to protect bank profits but rather that it wants to avoid the kinds of financial failures that plagued the economy in 2008-09.
Although neither Powell nor other Fed governors have mentioned it, they might also resist negative interest rates for fear of the damage they might do to the business confidence needed to promote recovery. Because the returns offered in financial markets naturally reflect returns available in the larger economy, policy that pursues negative rates effectively announces that economic prospects are also low or negative. The relationship stands to reason. When businesses believe that returns to economic endeavor are high, they will happily borrow so as to pursue those returns and accordingly push up lending rates in financial markets. When businesses doubt returns to economic endeavor, they lose their appetite for borrowing and expansion even when interest rates are low or negative. Low and especially negative returns hint at this sad condition. When countries such as Japan and Germany have pursed negative interest rates, they have implicitly announced some deeper economic malaise, perhaps the need for regulatory or trade reform or a change in labor law to raise returns available to economic endeavor. Monetary policy, even if it forces negative interest rates, cannot answer such needs. To be sure, very low interest rates say something similar, but negative rates are a thing apart.
In response to all these considerations, Chairman Powell has countered the president’s pressure by pointing to the lower risks and greater efficacy of monetary policies already in place. The Fed has, after all, brought short-term interest rates down near zero so that it is effectively costless or very inexpensive for businesses to borrow. Under the broad heading of “quantitative easing,” the Fed has also entered financial market through a number of programs to provide copious amounts of liquidity for individual and business borrowers, as well as for municipalities and states. All these measures should help protect the stability of financial markets, Powell contends, and promote a robust recovery as anti-virus strictures lift and do so, he implies, without the distorting risks introduced by negative interest rates.
Whatever the economic fundamentals or the experience abroad, the dispute between the president and the Fed will play out in the political and not the economic arena. If the economy responds smartly to the re-opening just now beginning, a gratified Donald Trump will look at the coming election with greater optimism. Needing less help from monetary policy he will likely ease the pressure on the Fed, and this latest interest rate dispute will evanesce. If, however, the economy fails to respond adequately to the re-opening and unemployment rates remain high, Donald Trump’s increasing desperation will redouble the pressure on the Fed, making negative interest rates a much greater likelihood, regardless of Chairman Jay Powell’s reasonable reservations and those of other Fed governors.This latest phase of the battle