Mike Walden Column: Should the Fed raise interest rates?

Published 4:17 pm Sunday, September 2, 2018

Our nation’s capital, Washington D.C., is a beautiful city of wide boulevards, historic memorials and buildings and political intrigue. I was fortunate to observe each of these in person 45 years ago when I was a summer intern. My greatest thrill was being mere feet away from President Nixon and Russian leader Brezhnev during a state visit.

Mike Walden

Suffice it to say, there’s never a dull moment in Washington. This was reinforced recently when President Trump called out the leaders of the Federal Reserve and criticized them for their policy of increasing interest rates. While this skirmish may not rise to the level of popular interest in other Washington battles, it does have important implications for the economy and economic policy-making.

First, let me provide a little background. The Federal Reserve is the central bank of the U.S. It has a regulatory role in making sure banks are safe. It can intervene with banks and keep those afloat who have hit hard times during a rough economy. We saw a lot of this kind of help by the Federal Reserve during the Great Recession a decade ago.

The Federal Reserve also has the ability to adjust interest rates in the economy up or down. The Fed’s influence is primarily over short-term interest rates, and the Fed implements its power through one key rate, then letting other interest rates adjust on their own.

The Federal Reserve’s power over interest rates is the main way the agency attempts to influence the path of the economy. It’s often said the Fed likes a “goldilocks economy,” meaning an economy that is not too hot, not too cool but just right. The Fed wants the economy growing and creating jobs, but not at too fast of a pace as to ignite more rapid increases in prices.

For example, when the economy was struggling during the Great Recession and immediately after, the Fed lowered interest rates to zero. This was designed to motivate borrowing and increase spending and revive the economy. Eventually the economy did come back — although economists disagree exactly why — but that’s a topic for another column.

Now the economy is growing, and some say it is growing at a rate twice as fast as in prior years. The unemployment rate is low and still falling, and the prices of many commodities, materials and products are rising more rapidly. So — in its pursuit of the goldilocks economy — the Fed is turning its attention away from worrying about growth to worrying about inflation.

As a result, the Fed in now increasing interest rates. It has already increased rates twice this year — for a total hike of 0.5 percentage points, and the bank is expected to do two more rate increases this year for a total of one percentage point.

Recently the Fed’s interest rate policy drew a reaction from President Trump, and it wasn’t complementary. The president worries the interest rate hikes will go too far in deterring borrowing and spending and slowing economic growth.

This is a legitimate concern. Economic policy is not like driving a car, where you know how much to push on the brake to slow the car to a specific speed. Instead, economic policy is like driving a new car with new technology each time you get behind the wheel, where every time you push on the brake the car slows by a different amount.

Indeed, economists have been surprised by how relatively tame inflation has been in recent years. Not too long ago I was on a panel with other economists, and one jokingly said, “I’ve been predicting faster inflation for each of the last four years, and I’m going to continue making this prediction until I get it right!”

Now, I’m not picking sides between the president and the Federal Reserve. I’m simply saying the economy is very, very difficult to predict, and there are usually defensible positions on both sides of most economic policy questions.

The president can voice concerns about the Federal Reserve’s interest rate hikes, but he can’t directly prevent them. Unlike cabinet departments like Defense, Treasury or Veterans Affairs (to name a few), the managers (actually called “Governors”) of the Fed do not report to the president, and the Federal Reserve has its own budget independent of both the president and the Congress.

But presidents do have one way to potentially shape the decisions of the Fed. Presidents appoint the Governors as well as the head of the Fed governors, called the Chair, with all subject to Senate confirmation. In fact, President Trump appointed current Fed Chairman Jerome Powell, earlier this year.

There are seven permanent members of the Fed’s Board of Governors, and because the terms are staggered and long, it’s unusual for presidents to be able to appoint all of them. But, as it turns out, President Trump may actually be able to appoint six of the seven. Of those he has yet to name, I’m sure he will quiz them about their views on interest rates.

It’s likely the Federal Reserve will wait until the fall to consider another rate hike. In the meantime, look for the Trump Administration to continue registering its concern about higher interest rates.

Most people want the goldilocks economy of good growth and low inflation. The question is — do we need higher interest rates to get it? You decide.

Mike Walden is a William Neal Reynolds Distinguished Professor and Extension Economist in the Department of Agricultural and Resource Economics at North Carolina State University who teaches and writes on personal finance, economic outlook and public policy.