Judging from commentary in markets late last week, an additional factor now features in the calculus of some Fed watchers as they look forward to this week’s two-day Federal Open Market Committee meeting: how will policy makers respond to President Donald Trump’s tweets suggesting that the central bank refrain from raising interest rates and risk “taking away our big competitive edge.”
Opinions vary a great deal, and for understandable reasons. Some feel that the Federal Reserve policy makers will go out of its way to ignore the pressure while others believe that it will have no choice but to be influenced by the president’s remarks. Within this latter group, there is even disagreement on how this influence will play out. With that, comes a higher risk of a policy mistake at a complicated time for central banking around the world.
Appreciating this, the Fed is likely to decide on policies and behave -- both internally and externally -- as if Trump’s remarks were never made. Yet, the Fed may have a difficult time avoiding misinterpretations of what it ends up doing and why.
The issue of political challenges for central banks is a longstanding one. History is full of cases of both overt and behind-the-scene politically motivated demands on these institutions to be more stimulative. A brief survey of them points to three basic things that traders and investors may wish to keep in mind as they think about how the Fed will -- and should -- respond this week.
No. 1. The influence of politics on central banks is not a new issue
The Fed has had a variable relationship with U.S. political leaders. To this day, Arthur Burns, Fed chairman from 1970 to 1978, is remembered for succumbing to pressure from President Richard Nixon to relax monetary policy in the run up to the 1972 election. This pressure was imposed both directly in face-to-face meetings (including Nixon urging Burns to “think of goosing it … late summer and fall of this year and next year”) and indirectly through newspaper leaks and threats to structurally increase the White House’s control of the institution. It followed earlier (and unsuccessful) attempts by President Lyndon Johnson to persuade Fed Chairman Willian McChesney Martin, to ease policy -- including one meeting in which Johnson is said to have complained that “my boys are dying in Vietnam, and you won’t print the money I need.” President George H.W. Bush, in the middle of a hotly contested re-election bid in 1992, also tried to not-so-subtly influence the Fed, saying “I’d like to see another lowering of interest rates.… I can understand people worrying about inflation. But I don’t think that’s the big problem now.”
The Fed isn't the only central bank dealing with political issues these days. Politicians haven't been shy in expressing strong opinions about the policies of the European Central Bank and the Bank of England.
Of course, the most egregious cases of persistent political influence on central banks come in emerging markets, and the outcome has typically included some mix of inflation, domestic and external financial turmoil and a de-stabilizing run on reserves. In the last few months it has been playing out most visibly for markets in countries such as Argentina and Turkey where concerns about political interference have led to considerable instability in exchange rates and risk spreads. And then there is Venezuela where heavy government interference in the central bank's operations has helped fuel an inflation rate that is heading to 1 million percent, according to the latest International Monetary Fund assessment.
No. 2. Political pressure tends to put central banks in a lose-lose position
No central banker wishes to wake up to news of increased political pressure.