Trump Is Right Again, Fed Must Halt Aggressive Hikes
To help the economy get out of the 2008–2009 recession, move quickly through recovery and into expansion, the Federal Reserve massively increased the money supply. They also drastically cut interest rates. This was done through a series of policy actions known as quantitative easing.
Interest rates began to fall in 2008 and by the end of 2009 the federal funds rate had fallen from 3.5% to .25%. By 2010 or 2011 the economy should have fully recovered from the deep recession. Instead the recovery was very tepid.
Historically, if a recession is deep, like it was in 1981, the economy should come roaring back like it did in 1984 when annual economic growth was 7.5%. But even with an extremely expansive fiscal policy that saw annual deficits exceeding $1 trillion, the Fed’s monetary policy actions failed to significantly increase economic growth. In fact, 2% economic growth became the new normal.
The Fed’s policy did help to end the recession but it was never able to get the economy into the expansion phase. The reason was because in 2010, Congress passed the Dodd/Frank bill which was intended to end predatory lending. It accomplished that, but because of vastly increased regulations, it also ended much of the other bank lending.
If banks are not lending money, there is no multiplying effect of the Fed’s actions. The result is small increases in growth. On the plus side, there is also small increases in prices.
President Donald Trump has set economic growth as his top priority. Since he cancelled hundreds of counter-productive regulations, the economy has been growing at a 3% rate.
Since April of this year, because of the Trump tax cuts and repeal of portions of Dodd/Frank, the economy has been growing at more than a 4% rate.
Growth for the current quarter will be estimated at the end of this month. It is likely to show that the economy is growing at a 4 ½% rate. Some economists and the Fed believe that growth could go even higher next year.
While the Fed would like to see that happen, their concern is inflation. After a series of rate hikes over the last 2½ years the federal funds rate is up to 2.25%. The Fed must now decide how much higher to raise rates and how quickly that should be accomplished.
Many members of the Fed want to aggressively raise interest rates to ensure that inflation does not become a problem. Since Trump has set economic growth as his top priority, he would like a more accommodating monetary policy. Trump’s strategy requires raising interest rates more slowly and after the economy records more high growth-rate quarters.
Which policy is the right one?
Most economists would likely take the position of the Fed. These economists look back at the 1970s and see a time when inflation grew which led consumers into an inflation psychology that led to even more inflation. Consumers would rush to purchase, because they believed the price would soon be much higher. That logic contributed to the prices rising.
Inflation psychology is difficult to reverse and could possibly lead to runaway inflation. So any hint of rising prices should be dealt with sooner rather than later.
Trump’s economists argue differently. They would say that the economy can grow at higher rates without triggering inflation. Essentially, they believe that inflation is mainly caused because total demand in the economy exceeds the business sector’s ability to supply.
They further argue that Trump’s economic policy is modelled after President Ronald Reagan’s supply side oriented economy policy. Trump has eliminated counter-productive regulations and reduced tax rates for all Americans including corporations, similar to Reagan’s action.
Because Trump cut taxes for the highest income earners, new capital will be created. Because Trump cut taxes for corporations, even more new capital will be created. Since the U.S. is a capital intensive economy, the new capital will give business the ability to increase supply to meet the new demand. So there will not be any inflationary pressure.
In the 1980s the U.S. economy experienced continued high growth and low inflation. Trump says that can happen now.
Trump also recognizes that his trade policy may result on some downward pressure on growth. He is using tough policy to re-write all of the trade agreements that are slanted in favor of our trading partners and to the detriment of the U.S.
Within the next year or so, he expects to have all of the trade agreements re-written so that foreign markets are opened to U.S. businesses well into the future. Until that happens, Trump doesn’t want to see the Fed get too aggressive with rates and possibly slow economic growth.
It looks like Trump is right again. Last month, the annual inflation rate fell slightly. Since the economy is finally entering an expansion stage, it is too early to be aggressive with interest rates.
Michael Busler, Ph.D. is a public policy analyst and a Professor of Finance at Stockton University in New Jersey, where he teaches undergraduate and graduate courses in Finance and Economics. He has written Op-ed columns in major newspapers for more than 35 years. @mbusler www.facebook.com/fundingdemocracy