April 11, 2019 / 5:10 PM / 10 months ago

Explainer: Five questions on Trump's feud with the Fed

WASHINGTON (Reuters) - President Donald Trump’s announced plan to name economic commentator Stephen Moore and businessman Herman Cain to the Federal Reserve board has come with assertions by the president the central bank is undermining economic growth and with demands from him for lower interest rates.

FILE PHOTO: U.S. President Donald Trump looks on as Jerome Powell, his nominee to become chairman of the U.S. Federal Reserve, speaks at the White House in Washington, U.S., November 2, 2017. REUTERS/Carlos Barria/File Photo

Both Moore and Cain are more overtly partisan than most previous nominees to the Fed, and Trump has been unusually critical of recent Fed decisions.

Here are the top issues at the heart of Trump’s beef with the Fed and his own hand-picked chairman, Jerome Powell:

Q) Is the Fed trying to slow the economy?

A) No. Policymakers say the U.S. economy is healthy enough to stand on its own, without the explicit central bank help reserved for more fragile economic conditions.

Trump has been frustrated that the Fed raised rates four times in 2018 as his signature tax policy went into effect. In all, seven of the Fed’s nine rate hikes since 2015 occurred after Trump took office in January 2017.

If not for that, he says, the economy would be performing like a “rocket ship” today instead of likely ebbing from last year’s 3 percent growth rate.

Still, the current level of interest rates in a range of 2.25 and 2.5 percent remains low relative to historical norms. Fed officials regard that level as near “neutral,” meaning it isn’t explicitly discouraging spending and investment, and from their perspective the rate hikes are not meant to impede the economy.

Q) Inflation is weak, so why did the Fed raise rates at all?

A) While inflation control is at the center of the Fed’s mission, Fed officials also set monetary policy in anticipation of other factors that can affect the outlook for the economy.

In the middle of last year it seemed the economy was poised to grow faster than expected for a while. A majority of Fed policymakers reasoned that keeping rates too low in that environment could pose other risks even if inflation remained tame. A chief concern was that low borrowing costs could create financial bubbles, which remains a core concern for policymakers after the financial crisis a decade ago.

To Powell and other officials, the issue is not just hitting the highest level of growth possible in any given year or quarter, it is hitting the highest level of growth that seems sustainable over time.

Q) Is the Fed overlooking different risks, like weaker overseas growth or financial market volatility, that would argue for lower interest rates?

A) Administration officials, and most recently White House economic adviser Larry Kudlow, said the administration is worried the Fed was ignoring other issues, such as slowing growth in China or the state of financial markets.

But throughout last year there was a growing group of officials inside the Fed concerned about just those problems.

That group reached critical mass in December as falling stock prices and widening credit market spreads fueled a rapid tightening of financial conditions. Even as the Fed raised rates that month, the central bank also began to shift gears and put further interest rates on hold.

Q) Is the Fed wedded to an outmoded economic view in which growth and low unemployment cause inflation?

A) Moore has said the Fed is stocked with “growth-phobiacs,” while Kudlow has argued the Fed holds a mistaken allegiance to the “Phillips curve” - an economic model measuring the relationship between employment levels and inflation. In their view, the Fed is overly concerned that if U.S. unemployment - currently near its lowest in five decades - falls too far that inflation will spike.

The tradeoff between inflation and unemployment is the subject of a longstanding debate at the Fed. Current officials now appear more open to seeing just how low the jobless rate can go without wages and eventually prices rising too fast.

Such a less-rigid approach comes with risks, however, and today’s Fed leaders remain mindful of past episodes when the Fed allowed unemployment to get too low for too long, as it did under political pressure in the 1960s.

That choice, when jobless rates were far below what was considered “full employment,” helped spark the runaway inflation of the 1970s, and forced subsequent Fed officials to impose some of the most punishing, and recessionary, interest rates ever.

Q) The president has been critical about more than just interest rates. What does that mean for things like “quantitative easing” and “quantitative tightening”?

A) Trump recently urged the Fed to return to the “quantitative easing” policies used during the crisis years. Under QE, the central bank gobbled up trillions of dollars in government securities to flood the financial system with cash and hold down long-term interest rates.

The policy was controversial at the time, and the Fed has since winnowed its holdings down. While that process - nicknamed “quantitative tightening” - will soon end along with the rate hikes, no one at the central bank thinks they should fire QE up again.

Indeed, with unemployment below 4 percent and the economy still growing, Trump’s call for additional QE has more in common with policies championed by some of the further left Democrats - those he brands socialists - than with the typical views of the Republican party.

Reporting by Howard Schneider; Editing by Dan Burns and Chizu Nomiyama

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