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Scapegoating the Fed Won’t Prevent a Recession

For starters, the outlook won't get better as long as there is uncertainty about our trade policy.
August 22, 2019
Scapegoating the Fed Won’t Prevent a Recession
Federal Reserve Board Chairman Jerome Powell. (Photo by Mark Wilson/Getty Images)

 Unlike was the case for Harry Truman, for Donald Trump the buck certainly does not stop with him. Rather, President Trump’s modus operandi is to take all of the credit for his policy successes and to assign all of the blame for his policy failures. 

In his relentless attacks on Federal Reserve Chairman Jerome Powell, Trump is acting true to form. Rather than recognizing that his protectionist trade policy might be the main culprit for U.S. economic performance falling short of his campaign promises, Trump chooses to set up Federal Reserve Chairman Jerome Powell as the scapegoat for any U.S. economic setback in the run-up to the 2020 presidential election.

A key campaign promise candidate Trump made in 2016 was to put the U.S. economy on a higher growth path. By deregulating the economy and by enacting a major tax cut, he promised a major investment boom. That in turn would allow the U.S. economy to grow on a sustainable basis by 3 percent to 4 percent a year, or at a very much faster rate than it did during the Obama years. 

To date, the reality has fallen well short of the hype. Far from booming, U.S. investment growth has been highly disappointing, with most of the corporate tax cut having been used for share buybacks rather than for new productive investment. Meanwhile, after recording a 2.5 percent growth rate in 2018, U.S. GDP growth has now decelerated to around 2 percent. That is below the economic growth rate recorded during the Obama years.

Worse yet, the recent inversion of the yield curve would suggest that the U.S. bond market is now strongly signaling that the U.S. could be headed for a recession in 2020. That inversion should not be taken lightly considering that the bond market has accurately forecast each of the last six U.S. economic recessions. 

Supporting the bond market’s gloomy economic view is not only the fact that the tax cut’s economic boost seems to  have faded. It’s also that both the U.S. and global investment outlook will continue to be clouded by heightened uncertainty as a result of U.S. trade policy. It will do so at the same time that the global economy could soon receive a body blow from the United Kingdom crashing out of Europe on October 31, from a turn for the worse in the Hong Kong crisis, and from renewed political turbulence in the highly indebted Italian economy. 

In its latest assessment of the world economy, the International Monetary Fund emphasizes the toll that President Trump’s America First trade policy has taken on the global economy. From a situation of a synchronized global economic recovery in 2018, the world has now moved to one of a global economic slowdown. It has done so as investors both in the United States and abroad have held back on investment decisions due to heightened uncertainty as to future trade arrangements. 

Judging by Trump’s continued hardline stance on the Chinese trade issue and by his recent threats to impose punitive import tariffs on European automobiles, he either doesn’t  appreciate how damaging his trade policy has been for both domestic and foreign investor confidence, or he is willfully ignoring the consequences. Instead, he chooses to blame the Federal Reserve for raising interest rates in December and for its reluctance now to  cut interest rates more radically and to engage in a new round of quantitative easing. 

While using Powell as a punching bag might be a smart political ploy in the run-up to the 2020 election, it is doubtful that it will do much to boost the U.S. economy. Indeed, it’s all too likely that such hectoring will make it more difficult for the Federal Reserve to cut interest rates, even if there were a reasonable case for so doing, for fear of appearing to be bowing to political pressure. It also likely will have the effect of further undermining investor confidence in the economy’s long-run performance by highly politicizing a key economic institution.

At a more basic level, there is no empirical support for President Trump’s repeated assertions that, if only the Fed had not raised interest rates in December and if only the Fed was now more aggressive in loosening monetary policy, the U.S. economy would now be growing in excess of 3 percent. 

Rather, most mainstream economists would subscribe to Milton Friedman’s view that monetary policy operates only with long and variable lags. They would also subscribe to the view that the main factor now holding back U.S. and global economic growth is not an excessively restrictive Federal Reserve but rather President Trump’s contribution to an uncertain economic environment.

James Carville famously remarked that when it came to winning presidential elections, what mattered was “the economy, stupid.” If President Trump wants to win the 2020 election, he might do well to heed Mr. Carville’s dictum. He then might concentrate less of his efforts on undermining the Federal Reserve’s independence and more on promoting a domestic and global environment that is friendly to investment.

Desmond Lachman

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund's Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.