Trump and monetary policy: Full Oped
This is a WSJ oped that I can now publish in its entirety. I posted some expanded comments with charts and graphs here a month ago. They may be especially useful to document my summaries of new-Keynesian models and empirical work.
Trump’s Monetary Policy Desires Aren’t Crazy
The policy world is aghast, but President Trump’s desires for monetary affairs aren’t as crazy as conventional wisdom portrays.
I see three broad desires: Interest rates should be lower, in part to lower interest costs on the debt. The Federal Reserve should be less independent, subject to more democratic accountability. And “exorbitant privilege” or “reserve currency status”—that the world wants to hold our money and buy our debt, sending us goods in return—damages the U.S.
The standard response: Lower interest rates will quickly lead to more inflation. But how soon, and how much? The best empirical estimates find that lower interest rates lead to no or slightly lower inflation for a year or so, then slightly higher inflation after two or three years. Even that response is barely significant statistically. And since the unexpected interest rate hikes these estimates study typically fade within a year or so, they say little about persistently lower interest rates.
Mainstream, or “new Keynesian,” economic theory predicts that a permanently lower interest rate will eventually lower inflation, other things (especially fiscal policy) held constant, even though inflation may temporarily rise. This is an unsettling implication that the theory’s largely center-left practitioners have trouble applying to reality, but there it is. Sure, maybe decades of consensus theory is all wrong. Economists have pursued wrong theories before. But if it’s in the equations of your own models, the proposition at least bears consideration.
The historical record is also mixed. That inflation went nowhere over a decade of near-zero interest rates, and three decades in Japan, seems to confirm this theoretical view that inflation is stable with a fixed interest rate—and that inflation will eventually follow higher or lower interest rates. Yes, low interest rates that financed large deficits contributed to inflation in many countries. But if a government doesn’t expand fiscal policy, the record is less clear. Yes, low interest rates in response to “supply” shocks, such as in the 1970s and 2020s, coincided with inflation. But the exact effect of low rates, and of other fiscal and nonfiscal responses, is also murky.
We economists don’t know with certainty just if, how, under what circumstances or how quickly low interest rates lead to inflation. I believe they do, despite the equations of my models, but that’s far from science.
The Fed has vastly expanded its scope of operations, propping up asset prices, monetizing debt, channeling credit, directing banks how to invest, straying into climate and inequality, and denying whole business models such as narrow banks and segregated accounts. These actions are political and cross over into fiscal policy and credit allocation. It has had no reckoning with its great institutional failures, including 10% inflation and repeated bailouts.
Independence isn’t an absolute virtue. Our constitutional order doesn’t include completely independent officials who can print money and regulate banks as they wish. It is reasonable to discuss reform. Either the Fed must be more “democratically accountable,” which is the same thing as “politically influenced” when the other party is in power, or it must be reformed to a narrow, enforced and accountable mandate so it can remain independent. As a small-government advocate, I favor the latter. But limited-government reforms are out of fashion and perhaps unrealistic. In any case, simply pulling up the drawbridge, hoisting the “independence” flag, and pouring boiling scorn on the barbarians at the gate isn’t a viable response.
In the consensus view, if the world wants our money and debt so much that we can just print it, send it abroad, and get consumer goods in return, the proper answer is a nice thank-you note. But one must admit this strategy has had downsides. Spain and Portugal minted the world’s money when they found gold and silver in the Americas and used it to buy consumer goods. Their industries languished and then ended up poor. Money is a form of the “resource curse” that befalls many producers of oil and other vital commodities. Switzerland refuses the world’s offer and remains productive.
Even neomercantilists have a little point buried in a heap of fallacies. Countries that run perpetual trade deficits to finance consumption, borrowing abroad to do so, eventually must pay back the debt. Saving and investing rather than borrowing and consuming is good for an economy as it is for a family.
The central problem in our case—and in much of history—is the bounty was consumed rather than invested. That choice flows from government deficits to finance consumption, and legal, tax and regulatory barriers that make private investment less profitable. Thus tariffs, capital controls, securities taxes and industrial policy will all make matters worse. Get out of the way instead. But in all three cases, there is some merit to the basic point, worthy of examination and not immediate disdain.
Mr. Cochrane is a senior fellow of the Hoover Institution and an adjunct scholar at the Cato institute.
“Sending money abroad” is a policy choice. An easy way to reduce the current account would be to reduce the fiscal deficit. I don’t see any commitment that even with lower debt costs, the administration would reduce the fiscal deficit.
The three "wants" listed in the opening of the article that appeared in the WSJ are those that S. Miron, and S. Bessent put forward a year-ago in the case of S. Miron, and earlier this year in the case of S. Bessent. There is no doubt that the administration desires "easy money", just as there is little doubt that the FOMC is resisting the urge to walk away from its "price stability" and "full employment" mandates. As for the regulatory expansion of the FRB, those accretions that post-date WWII are the result of Congressional acts that passed into law as a result of earlier financial crises which Congress perceived as arising from gaps in the federal law governing banking industry practices. It did not arise because the FRB sought enhanced powers over the bank sector for itself in pursuit of self-aggrandizement (i.e., independent "power" over the banking system for its own sake).
The weakness in the argument is the demand for political accountability. This, coming from the Trump administration, is simply a 'ruse de guerre'. Independence of the Federal Reserve System is coded in legislation adopted over the years since the FRB gained a measure of independence from the Truman administration's treasury department. Since that date, successive acts of legislation ("bills", if you will) have without variation restated the independence of the FRB and increased the degree of independence of the Fed with each new bill passed by Congress and signed into law the then-current president. With those bills, political accountability was repeatedly restated. "The political accountabiilty channel?", you ask. "Congress", the congressmen answer. "You have a republic, if you can keep it", Founder was reported to have once stated. It is not as though the FRB generated these changes on its own.
One might be led to believe, based on Miron and Bessent, and now Cochrane, that the FRB is a rogue player who is using "independence" as a cudgel to defeat the forces of "political accountability" ("pouring boiling water" on the beseigers surging forward against the battlements of the Fed's fortress, to paraphrase JHC).
The opinion ("commentary") piece above overlooks the dynamics of the American banking sector that has had a traditional aversion to centralizing the banking industry in the City of New York. This aversion informed the drafters of the 1913 Federal Reserve Act. That aversion continues to this day. That is why you have 12 Federal Reserve Banks and 12 territories, one for each Federal Reserve Bank, that the Federal Reserve Banks are responsible for. The ownership structure of the Federal Reserve Banks also reflects that aversion to centralized banking control in NYC.
S. Bessent wants to "modernize" the FRB system, ditching the FRBs and their staffs of Ph.D.s in favor of centralized control under the Unitary Executive. That's a Project 2025 goal.
The first step in the plan is to obtain voting control over the Federal Reserve System board of governors. The second step is to fire the 12 sitting presidents of the Federal Reserve Banks, and install new presidents that are simply "rubber-stamps" for the administration to effect the third step. The third step is reduce the independence of the 12 regional Federal Reserve Banks by doing away with the private ownership of those banks by the regional commercial banks in each of the 12 territories. The fourth and final step is to take full control of the FOMC and thereby control U.S. monetary policy. This is the "Argentina on the Delaware River" nuclear option.
You don't believe it? Read Miron and Bessent. They aren't academics wedded to theoretical monetary policy or macro-economic theory. They're private capital investment fund operators (one failed, and one wildly successful). They're the "nuts-and-bolts" crew. And, they mean to seize the wheel-house of U.S. monetary policy and control it for political and financial ends.
Turn to the U.S. dollar -- what makes the U.S. dollar the world's primary reserve currency and NYC the single-most influential money center today? Answer: the willingness to provide liquidity at all times under all conditions to foreign borrowers and governments even at penalty interest rates. See, S. Bessent's bail-out of Millei's government in Argentina with a U.S. dollar to Argentinian peso currency swap arrangement, to be followed-up by a short-term lending facility led by a commerical bank consortium of U.S. money-center banks. See also, the refusal of the U.S. government to condone the seizure of impounded Russian government financial assets and conversion of the same into funds that might be used to finance Ukraine's war effort going forward--to do so would put into question the role of the U.S. dollar as the world's primary reserve currency, and weaken the U.S. government's hold over the global economy and its ability to impose financial sanctions on enemy governments.
"What-if?" musing is an interesting past-time, but not a material source of actionable policy prescriptions.