An ugly economic lesson from the Nixon era proves why Trump's criticisms of the Fed are so worrying
- President Donald Trump has criticized the Federal Reserve’s current path of interest-rate hikes twice in the past two days.
- The criticism drew concerns about the Federal Reserve’s political independence.
- Presidents have pressured the Fed before, most notably Richard Nixon.
- Nixon convinced then-Fed Chairman Arthur Burns to keep interest rates low, leading to nearly a decade of economic problems.
For two straight days, President Donald Trump has committed a major break in American political convention by commenting on the actions of the Federal Reserve and the criticism echoes one of the worst monetary-policy mistakes in US history.
On Thursday, Trump told CNBC he was “not thrilled” about the Federal Reserve’s interest-rate hikes, breaking with the long-standing precedent of American presidents not commenting on Fed policy out of respect for the central bank’s independence from political influence.
“Because we go up and every time you go up they want to raise rates again,” Trump told CNBC in an interview that aired in full Friday. “I don’t really — I am not happy about it. But at the same time I’m letting them do what they feel is best.”
Trump followed up the CNBC comments with a tweet on Friday, in which the president said the Fed’s interest-rate tightening “hurts all that we have done.”
While the White House attempted to assuage concerns by reiterating the president’s support for the Fed’s independence, the comments still raised the spectre of a huge policy mistake from the 1970s.
Richard Nixon, the Fed, and stagflation
The Federal Reserve’s structure is unique within the US bureaucratic system. It operates within government, but simultaneously remains relatively independent with some oversight from Congress.
The Fed’s independence is couched in the belief that for the central bank to achieve its aims — ensuring financial stability and long-term growth — it should be free from the pressure that might be exerted by politicians seeking to alter policy for their own ends, rather than putting the country’s prosperity first.
The most notable example of a president violating this edict independence of the Fed occurred under Richard Nixon in the 1970s.
In the run up to the 1972 election, Nixon wanted to present the country with a strong economy and low unemployment. To do so, Nixon swapped out Fed Chairman William McChesney Martin with his pick, Arthur Burns.
Nixon pressured the new Fed chairman to keep interest rates low to help maintain lower unemployment. The released Nixon tapes revealed numerous conversations between the president and Burns in which Nixon pressures the Fed chair to keep rates low. Nixon even told advisers “we’ll take inflation if necessary, but we can’t take unemployment.”
Burns did in fact keep rates relatively low, but the move proved to be disastrous as it helped to usher in a period of stagflation — high inflation, high unemployment, and low economic growth.
Not until Paul Volcker took over the Fed nearly a decade later and ratcheted up interest rates in what is known as the “Volcker Shock” would the issue be truly corrected.
Other incidents, including President George H.W. Bush complaining about the policies of his Fed chair, Alan Greenspan, have also occurred, but the comments were far more muted than Nixon’s extended pressure.
Nixon’s attempts to influence provide a perfect example of why defenders of Fed independence are so fervent in their belief that politicians should not attempt to tamper with monetary policy, but there is also empirical evidence for independence as well.
Gregory Daco, chief US economist at Oxford Economics, pointed to research by Alberto Alesina and Lawrence Summers that showed in countries with a politically influenced central bank had higher inflation.
“While reviewing 16 OECD economies, they showed that countries with independent central banks generally had lower inflation without ‘suffering any output or employment penalty’,” Daco said. “As such, central banks acting outside of the political sphere of influence would be most desirable in any country.”
The evidence further supports the independent mission of the Fed and makes it important for presidents to keep out of monetary policy. While Trump is far away from Nixon’s level of interference, Daco said it is important to keep an eye on.
“While current conditions are very different from those of the 1970s, we must not forget that the premise of central bank independence rests on the advantage of insulating monetary policy from short-sighted political objectives,” he said. “While inflation expectations are currently well anchored, history shows us that a pervasive lack of central bank independence can rapidly, and without warning, lead to rising inflation and economic instability.”
Read the full article from it’s original source: http://uk.businessinsider.com/trump-federal-reserve-interest-rate-attacks-echo-nixon-disaster-2018-7