Miton - Has the Fed been Trumped?

The essence of democracies is that power (government) should be elected and held to account through regular elections. There’s a wider discussion about where real power lies, for example private organisations like Google, whether democracies function as well as they should and, indeed, whether they are actually that democratic.

Over recent years, there has been a trend for independent agencies to grow materially, to the degree that they have become an important part of modern democracies. These agencies are meant to be arm’s length from government, or at least insulated from short term political interference, allowing them to focus on the long term public good. That said, there can be a fine line between being independent and being unaccountable.

Central banks haven’t been immune to this trend towards independence. After the inflation of the 1960s and 1970s, there was growing pressure to make central banks independent of politicians and election cycles. The logic being that the incumbent party would typically want central banks to ease monetary policy ahead of elections, thereby boosting the economic environment and increasing their chances of holding on to power. Instead, independent central banks can have an eye on the longer term macro environment and worry less about whether their actions are unpopular in the short term.

The US Federal Reserve is an independent government agency but is ultimately accountable to Congress who, for example, set their objectives. Elsewhere, the Bank of England became independent in 1997 and the European Central Bank, established in 1998, was independent from the beginning. Being independent doesn’t mean central banks aren’t political, at the very least, they have to be politically streetwise.

Importantly, the advantage most central banks have over many other independent agencies is that they have clear, concise and measurable objectives, i.e. emphasising inflation but often including employment and growth too. This provides a degree of public transparency and accountably.

However, on the back of the 2007/8 crisis, the remit of central banks expanded materially and strayed into areas that were previously the preserve of politicians. As central banks gained significant power, often without clear objectives, so their status as unelected bodies came into focus.

Of late, central bank independence has been brought into question again. In the context of the Fed raising rates, Trump recently said “I’m not thrilled, because we go up and every time you go up they want to raise rates again…I am not happy about it. But at the same time, I’m letting them do what they feel is best”. The last sentence doesn’t sound as though the Fed is particularly independent and, more generally, this is a marked change compared to the last 20 years, where the White House has had a tradition of avoiding comment on Fed policy, out of respect for their independence. More recently, perhaps anticipating external pressures, or simply wanting to appear independent, the new Fed chair (appointed by Trump) confirmed that he would preserve the Fed’s “independent and non-partisan status”.

It is unlikely that the Fed will pause policy on the back of Trump’s recent comments alone and in that sense it does little to erode the Fed’s independence (certainly, market expectations for interest rates are little changed). Nevertheless, the immediate concern for Trump remains tighter domestic financial conditions (due to higher US interest rates, a higher gasoline price and a slightly stronger US dollar), as the US November mid-term elections loom. These are factors working against Trump’s stimulatory tax reform and perhaps eloquently highlights why central banks need to operate without political interference.

As ever, we look to bring the debate back to the data. Surveys suggest that global growth has slowed from unsustainably high levels and financial market moves have been consistent with this, as defensives have been outperforming cyclicals and industrial metals have been selling off. So, perhaps the more relevant pressure for the Fed is not Trump and their independence from him but whether or not the forthcoming data highlights a Fed that is too aggressive and, to some extent, here we can circle back to Trump again, but this time through the escalating trade wars, for which he is the key actor.

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