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Dudley’s really bad advice

Summary:
This advice from former NY Fed President Bill Dudley is really bad: “I understand and support Fed officials’ desire to remain apolitical. But Trump’s ongoing attacks on Powell and on the institution have made that untenable,” Dudley wrote, referring to Fed Chair Jerome Powell. “Central bank officials face a choice: enable the Trump administration to continue down a disastrous path of trade war escalation, or send a clear signal that if the administration does so, the president, not the Fed, will bear the risks — including the risk of losing the next election.” This is how the Fed loses its independence. Ironically, at the moment the Fed has more independence than at any time in its history. It knows that Congress is totally gridlocked, and that the Democratic House

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This advice from former NY Fed President Bill Dudley is really bad:

“I understand and support Fed officials’ desire to remain apolitical. But Trump’s ongoing attacks on Powell and on the institution have made that untenable,” Dudley wrote, referring to Fed Chair Jerome Powell. “Central bank officials face a choice: enable the Trump administration to continue down a disastrous path of trade war escalation, or send a clear signal that if the administration does so, the president, not the Fed, will bear the risks — including the risk of losing the next election.”

This is how the Fed loses its independence. Ironically, at the moment the Fed has more independence than at any time in its history. It knows that Congress is totally gridlocked, and that the Democratic House would fully support the Fed in any battle with Trump, over any issue. Congress is not about to rein in their power. But as much as I’d like to see Trump lose the next election, this is a lousy idea.

Instead, the Fed should be asking Congress to give them more power to prevent the next recession. Call it a “pro-growth monetary policy”. Both the Dems and the GOP would lap that up right now. I’ve provided numerous suggestions in other posts.

BTW, this Dudley comment tends to confirm my view that Trump’s pressure is likely to have either no effect or lead to tighter money. Why would Trump do this, knowing how a prickly independent institution would react to his pressure tactics? This is why I continue to insist Trump’s not a master dealmaker. Since taking office he’s failed at every single attempt to twist arms to get his way. Remember when he needed McCain’s vote to repeal Obamacare, and he insulted McCain by mocking the fact that he was captured and tortured by the North Vietnamese. How dumb can you get? In contrast, LBJ knew how to persuade people—that’s what a master manipulator actually looks like.

Here’s the NYT:

It is unclear whether Mr. Trump has the legal authority to demote Mr. Powell, who was confirmed by the Senate to a four-year term as chair. Mr. Powell’s term as a governor does not expire until 2028.

If Mr. Trump did try to strip Mr. Powell of his title, the currently 10-member Federal Open Market Committee — which sets interest rates and selects its own chair — might elect him as its leader, one Fed official said on background.

That would create an unprecedented power divide, with Mr. Trump’s new nominee serving as chair of the Board of Governors, assuming that person was confirmed by the Senate, and Mr. Powell heading the policy-setting committee.

Should the Fed adopt this “nuclear option”? I’d say only if it was needed to fulfill their congressional mandate. The Fed needs to be like the computer HAL in the film 2001—focused like a laser on achieving its goal. (I hope it will have better judgment than HAL.) The Fed should only do this end run around the newly appointed chair if that person threatens to push the Fed off course. And I don’t expect that to happen—I doubt the Senate would approve a candidate who is that whacky, and I doubt the other Fed policymakers would vote with him or her if they did.

BTW, I see that respectable people are coming around to my longstanding claim that America is now the world’s rogue nation:

“We are in a system in which things are getting worse day by day, and it’s not a service to anybody, at least privately, to not focus on what the key problems are — and they would be the behavior of the United States, unfortunately,” Stanley Fischer, a former Federal Reserve vice chairman appointed by Mr. Obama, said at the event.

The NYT did not mention the fact that technically it is the Board of Governors that sets IOR, not the FOMC. That’s one reason why I believe the current IOR program is illegal. As implemented, the IOR is often set at a rate above short-term market rates, even though Congress instructed them not to do so. (The Fed relies on a technicality for violating the clear meaning of the law.)

This is important, as Congress clearly did not intend this sort of floor system, where the regional Fed presidents would be disenfranchised. The point of IOR was to make the opportunity cost of holding reserves lower, not to create a dramatically different monetary regime, where monetary policy would be implemented via changes in the demand for base money, not the supply of base money (as prior to 2008.) I defy anyone to find any evidence that Congress intended such a radical policy shift when this change was rushed through in early October 2008.

When asked if they would ever do such a thing, have the Board take over policymaking from the FOMC, Fed officials tend to recoil in horror. “Of course we’d never defy the clear intent of Congress.”

You can’t say Fed officials don’t have sense of humor.


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Scott Sumner
Scott B. Sumner is Research Fellow at the Independent Institute, the Director of the Program on Monetary Policy at the Mercatus Center at George Mason University and an economist who teaches at Bentley University in Waltham, Massachusetts. His economics blog, The Money Illusion, popularized the idea of nominal GDP targeting, which says that the Fed should target nominal GDP—i.e., real GDP growth plus the rate of inflation—to better "induce the correct level of business investment".

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