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Macro Wrap-Up: An Unprecedented Short History of Fed Independence

July 27, 2018

After last week’s Wrap-Up on the Powell Fed, we got a lot of questions on executive interference in U.S. monetary policy and currency markets. 1The questions were mostly along the lines of: “Are President Trump’s criticisms of the Fed unprecedented?” The answer is straightforward: they are completely precedented. 2In fact, the comments criticizing the Fed’s rate hikes may be the most precedented thing the administration has done. It’s understandable that young folks may not remember all of the past conflicts over Fed independence because the past three administrations have, for the most part, let the Fed set monetary policy as it wished. 3However, by the standards of the 1960s, 1970s and 1980s, Trump’s comments were very tame.

Modern Fed independence dates back to the post-World War II period. 4The U.S. government borrowed enormous amounts to finance its participation in the War and then used the Fed to monetize the debt by mandating low yield targets. 5This led to double digit inflation in the late 1940s. Many Fed members, including Chair Marriner Eccles, objected. In 1948, President Truman responded by replacing Eccles.6 Tensions between the Fed and the Treasury were finally resolved by the famous 1951 Accord, which granted the Fed autonomy over monetary policy. 7The Accord allowed the Fed to set rates based on economic considerations rather than using it as a financing tool. But even though independence was the official policy, it was challenged numerous times in the following thirty years. For the most part, governing parties wanted lower rates to stimulate the economy with the not-so-hidden agenda of improving their electoral chances. 8There were some colorful confrontations between politicians and the Fed.

Three weeks after the Accord, William McChesney Martin Jr. took the helm at the Fed. He gained a reputation as a solid inflation fighter, but after a few years he was caught in President Johnson’s crosshairs. 9After Martin cast the deciding vote for a 50bps rate increase, Johnson called him to his Texas ranch. According to reports, Johnson grabbed Martin by the arm and threw him against a wall. “Martin, my boys are dying in Vietnam and you won’t print the money I need” he said.1 0Richard Nixon was equally creative in his approach to the Fed.11 During the run-up to the 1972 election, Nixon and his advisor George Shultz pressured Martin’s successor Arthur Burns to increase the monetary supply. Nixon was very blunt about how a stronger economy would help his campaign and referred to the “myth of the autonomous Fed.” In an effort to be even more persuasive, Nixon also leaked false stories about Burns requesting a pay increase.

We don’t know how much the not-so-subtle pressure affected monetary policy, but it probably wasn’t a coincidence that these incidents were followed by periods of rising inflation. By the late 1970s, inflation had gotten so high that Jimmy Carter had little choice but to allow Paul Volcker to raise rates to previously unseen levels. After defeating Carter in the 1980 election, Ronald Reagan reappointed Volcker. However, when Volcker voted for continued tight policy, despite more moderate inflation levels, Reagan replaced him with Alan Greenspan. 1 2Greenspan did not loosen monetary policy immediately. Some economists think that he may have purposely kept rates high to prove his independence and to establish his inflation fighting credentials. It was not long before the stock market crashed in October of 1987. That may have been a coincidence.

The market eventually recovered, but Greenspan later faced harsh criticism from George H.W. Bush for not cutting rates more aggressively prior to the 1992 election. “I reappointed him and he disappointed me” H.W. poetically lamented.1 3His son, George W. Bush did not interfere in monetary policy at all during his term, nor did President Obama. By Greenspan’s account, W. believed in monetary policy independence. It’s more difficult to know what Obama thought on the issue because the Fed was so aggressive with its easy money policies that there wasn’t much for him to ask.1 4Now that rates are rising, it shouldn’t be too surprising that a President wants easier policy. Some have argued that Powell will respond like Greenspan and tighten rates more quickly. Others have argued that he will cave in as Burns and Martin are alleged to have done. The more likely outcome is that he just ignores the pressure and hikes rates slowly. That would be truly independent. If we do start to see a more meaningful erosion of Fed independence, it is reasonable to expect a sustained rise in inflation and low real rates. The past experiences are not conclusive but they point in that direction.

Trump’s comments on the dollar are different, in part because the strong dollar policy in its current form only dates back to the Clinton administration. It doesn’t carry the weight of Fed independence nor does it have the history of being trampled on. The strong dollar policy is really only rhetoric, but in foreign exchange, rhetoric can move markets. If the administration were to commit to a weaker dollar policy, it could be successful. Of course, it could trigger reactions from other countries and could lead to a round of competitive devaluations. Fortunately, we’re not there yet. Soon after Trump’s comments, Treasury Secretary Mnuchin said the U.S. was committed to the strong dollar policy.1 5This seems to be the pattern with the administration and the dollar. You could even say it was precedented.

What We Are Watching

Bank of Japan Meeting (Tuesday) The Bank of Japan’s monetary policy meeting will take place amid recent speculation of potential 1 adjustments to the bank’s monetary easing framework. The speculation was ignited by news, citing undisclosed sources, indicating that “unusually active discussions” are taking place within the BoJ ahead of the July meeting “with changes to [the central bank’s] interest-rate targets and stock-buying techniques on the table.”1 6The sources noted that discussions were contingent on the board members’ inflation forecasts to be updated in the upcoming meeting. Any changes that can be perceived as a withdrawal of stimulus would pose a communication challenge for the BoJ given persistently low inflation in Japan.1 7The market will be particularly focused on potential changes to the yield curve control scheme and the ETF-buying program.

FOMC Meeting (Wednesday) - Bank of England Meeting (Thursday) Market pricing for both the FOMC and BoE meetings implies no changes in policy rates next week. On the FOMC front, Chairman Powell’s prepared remarks to Congress last week reiterated the committee’s expectation of continued strength in the labor market and inflation stability near 2% over the next several years.1 8Powell also noted that the effects on the economy of the current discussions over trade policy are still uncertain. On the BoE front, Governor Carney recently expressed increased confidence that the softness of U.K. activity in Q1 was largely due to weather factors. He noted that should the economy perform in line with his expectations, “ongoing tightening of monetary policy over the next few years would be appropriate,” without specifying the timing of a hike.1 9With rates unlikely to change, market focus will be on language changes in both central banks.

U.S. Employment Report (Friday) The July employment report in the U.S. will be released on August 3. While job creation has been remarkably strong this year, rising from 182,000 jobs per month in 2017 to 215,000 jobs created in 2018 on average, wage inflation has remained unchanged relative to December 2017 at 2.7%.2 0Wage growth has been muted despite the unemployment rate falling 0.5% below the FOMC’s 4.5% estimate of the long-term unemployment rate.2 1Perhaps contributing to the lack of wage inflation, labor force participation among workers aged 25 to 54 years has been trending higher steadily since late 2015, rising from 80.6% to 82% in June.22 Market focus will likely be on wage inflation, job creation, and the unemployment rate.

[1 ] For the key comments from Trump’s CNBC interview last week, see CNBC: “Trump lays into Federal Reserve, says he’s ‘not thrilled’ about interest rate hikes,” 7/19/18.

[2 ] Or perhaps “Presidented.” My spellcheck is saying “precedented” is not a word either. Then what’s the opposite of unprecedented, spellcheck??

[3 ] Old folks may not remember either.

[4 ] Prior to the Fed, Andrew Jackson fought with the President of the Second Bank of the U.S., Nicholas Biddle. Jackson won that fight and the Bank of the U.S. was ultimately dissolved.

[5 ] This was one of the earlier examples of yield curve control. For a summary of the policy and the economic backdrop, see: Bank of Japan: “History and Theories of Yield Curve Control,” 1/11/17.

[6 ] Eccles was able to stay on the Fed, just not as Chairman. Eccles is considered a hero by many economic historians and the main office of the Board of Governors in Washington D.C. carries his name today – the Marriner S. Eccles Federal Reserve Board Building.

[7 ] The 1951 Accord, also known as the Treasury-Fed Accord, only came about after President Truman falsely told the press in early 1951 that the FOMC had agreed to support the Treasury’s interest rate peg. Eccles released the FOMC minutes showing otherwise. Source: Federal Reserve History: “Marriner S. Eccles.”

[8 ] Politicians think voters like strong growth.

[9 ] For a summary of Martin’s interaction with President Johnson, see: New York Times: “A President at War With His Fed Chief, 5 Decades Before Trump,” 6/13/17.

[10 ] Oddly, he later reappointed Martin.

[11 ] For a summary of Burns’s interaction with President Nixon, see: Abrams, Burton, A. 2006. "How Richard Nixon Pressured Arthur Burns: Evidence from the Nixon Tapes." Journal of Economic Perspectives, 20 (4): 177-188.

[12 ] Volcker technically resigned, but it was unlikely he would have been reappointed again. Reagan disagreed with Volcker on regulation as well as monetary policy.

[13 ] “Bush Pins 1992 Election Loss on Fed Chair Alan Greenspan,” Wall Street Journal, 8/25/98.

[14 ] It probably would not have made sense to throw Bernanke up against a wall to ask for QE4.

[15 ] “After Trump’s Fed Comments, Mnuchin Offers a Clarification,” New York Times, 7/21/18.

[16 ] “Exclusive: BOJ to debate policy change in July to make its stimulus sustainable: sources,” Reuters, 7/20/18.

2 [17 ] Bloomberg data for Japan Nationwide CPI ex Fresh Food and Energy

[18 ] Federal Reserve: Chairman Testimony “Semiannual Monetary Policy Report to Congress,” 7/17/18.

[19 ] “Stronger U.K. Growth Shows Need for Higher Rate, Carney Says,” Bloomberg News, 7/5/18.

[20 ] Bloomberg data for U.S. nonfarm payrolls and average hourly earnings of all private employees

[21 ] Bloomberg data for U.S. unemployment rate, Federal Reserve “Summary of Economic Projections,” 6/13/18.

[22 ] Bloomberg data for U.S. labor force participation rate 25-54 years

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