Why the US Federal Reserve may be Trump’s next target

By Paul Krugman

Interest rates in the world’s largest economy are heading down. Maybe not today, and maybe not tomorrow, but soon, and for the rest of this year (at least).

Why? Because there are very good reasons for the US Federal Reserve, which controls short-term interest rates — that’s how it makes monetary policy — to start reversing the sharp rate hikes it carried out beginning in March 2022. There’s a vigorous debate about whether those rate hikes were excessive, which I’m not going to litigate here. Whatever you think about past policy, the case for cuts going forward is very strong, and I hope the Fed will act on that case.

Former US president Donald Trump could be looking to pressurise the Federal Reserve.
Former US president Donald Trump could be looking to pressurise the Federal Reserve.Credit: AP

What I don’t know is whether the Fed is ready for the political firestorm it’s about to face and whether it will stand up to the pressure to keep rates too high for too long. Because it’s a safe prediction that Donald Trump and his supporters will scream that the coming rate cuts are part of a deep-state conspiracy to reelect President Joe Biden.

Let’s talk first about the economics, which should, but might not, be the only thing guiding the Fed’s decisions.

The Fed raised rates in an attempt to rein in inflation in the US, which was running hot at the time. Its preferred measure of underlying inflation was running far above its target rate of 2 per cent. It kept raising rates until the middle of 2023, trying to cool off the economy and ensure that inflation came down.

As it turns out, the US economy still hasn’t cooled much, at least by the usual measures; the unemployment rate remains near a 50-year low. But inflation has plunged. Over the past six months, the core personal consumption expenditures deflator has risen at an annual rate of only 1.9 per cent, below the Fed’s target, and more complex measures are close to 2 per cent. Basically, the war on inflation is more or less over, and we won.

US Federal Reserve chairman Jerome Powell is expected to start cutting rates this year.
US Federal Reserve chairman Jerome Powell is expected to start cutting rates this year.Credit: AP

So why keep interest rates this high? Right now the US labour market looks a lot like it did on the eve of the pandemic, with both unemployment and other measures of market heat, like the rate at which workers are quitting, similar to what they were in late 2019. The Fed is projecting higher inflation over the next year than it was in 2019, but only slightly higher.

Back then, however, the federal funds rate, the interest rate the Fed controls, was 1.75 per cent. Now it’s 5.5 per cent. It’s really hard to come up with a good reason it should stay that high.

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True, high rates haven’t produced a recession — yet. But there are hints of economic weakness, and the Fed is supposed to try to get ahead of the curve. So it’s time to start cutting rates.

But rate cuts will have political implications. They will be good for Biden, although not exactly for the reasons you might think.

I don’t know what the unemployment rate or the rate of economic growth in the US will be in November, but because monetary policy works with a lag, what the Fed does in the next few months won’t have much effect on these numbers.

Biden, however, is already presiding over a very good economy by normal standards, with solid job growth and plunging inflation. What he needs is for more Americans to accept the good news. And Fed rate cuts will help him with that. They will signal to the public that inflation really is under control; they will lead, other things being equal, to higher stock prices and lower mortgage rates.

So we can expect howls from Trump and his allies that politics, not economics, is driving the coming rate cuts, even though Trump himself appointed Jerome Powell, the Fed’s chair.

Why do we know this will happen? Partly because paranoia is MAGAworld’s normal condition: It sees sinister conspiracies everywhere.

‘Boneheads’

Beyond that, Trump and his allies constantly engage in projection, assuming that their opponents are doing or will do what they themselves would do or have done, like weaponising the US Justice Department for Trump’s own political ends.

And when it comes to interest rate policy, Trump has a track record of doing exactly what I’m sure he will accuse Biden of doing: trying to manipulate the Fed. Ever since Richard Nixon pressured the Fed to keep rates low in 1972, possibly helping to set the stage for the stagflation that followed, it has been traditional for the White House to respect the Fed’s independence.

But in 2019 Trump attacked Powell and his colleagues as “boneheads” and demanded that they cut interest rates to “ZERO, or less.”

So we know that Trumpist attacks on the Fed for cutting interest rates are coming. What we don’t know is how the Fed will react.

In a recent dialogue with me about the economy, my colleague Peter Coy suggested that the Fed may be inhibited from cutting rates because it’ll fear accusations from Trump that it’s trying to help Biden. I hope Fed officials understand that they’ll be betraying their responsibilities if they let themselves be intimidated in this way.

And I hope that forewarned is forearmed. MAGA attacks on the Fed are coming; they should be treated as the bad-faith bullying they are.

This article originally appeared in The New York Times.

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