Monetary Policy: Donald Trump and Janet Yellen Look to Be on a Collision Course
It is Ms. Yellen’s clearest indication to date that the era of extraordinary efforts by the central bank to get the economy back in shape is nearing its end. The Fed has raised short-term interest rates in each of the last two Decembers, and it is looking likely that there will be more than one rate increase this year. She said in her speech that she and her colleagues were expecting to increase the federal funds rate “a few times a year.”
As central bankers are wont to do, Ms. Yellen emphasized that those plans were contingent on the economy’s behaving as the Fed expected. If inflation starts to slip again, or improvements in the job market recede, the Fed will presumably hold off. But she spoke clearly of the risks of moving too slowly toward the so-called neutral interest rate that neither stimulates nor slows the economy. “Waiting too long to begin moving toward the neutral rate could risk a nasty surprise down the road,” she said. “Either too much inflation, financial instability or both.”
But if things go as planned, there is a clear risk that the Fed’s goals could be on a collision course with the Trump administration’s goals.
The president-elect and his advisers have often spoken of seeking stronger economic growth than the United States has experienced the last several years, perhaps seeking 3.5 percent to 4 percent instead of the sub-2 percent growth that has been the standard since 2009. A white paper by advisers to Mr. Trump released in the fall assessed the view that this lower growth rate reflected demographics and that it amounted to a “new normal,” and declared it “incomplete — and unnecessarily defeatist.”
That view is at odds with both Ms. Yellen’s comments Wednesday and longer-term economic projects that Fed officials have released. For example, the median Fed policy maker viewed the economy’s long-term rate of G.D.P. growth as only 1.8 percent a year, very much in the ballpark that Trump advisers would view as unnecessarily defeatist.
So here’s one way things could go: The Fed steadily raises rates, to the degree that employment and inflation data cooperate with their forecasts, with faster rate increases the higher growth rises. It’s possible that what people in Mr. Trump’s orbit view as a desirable boom will look to Ms. Yellen and her colleagues as overheating, and prompt equal and opposite interest rate increases.
There are a couple of potential twists in this story. The first would involve potential Trump appointments to the Fed; the second could involve big moves in the dollar.
Ms. Yellen’s term as chairwoman expires in about a year. Mr. Trump could appoint a new leader to the Fed who is more hospitable to his view (though she would have the option of continuing her time as a Fed governor, one of seven policy makers who are appointed to 14-year terms). There are two governor vacancies available now, so Mr. Trump could quickly influence the direction of the Fed with new appointees.
But it’s not clear whether any new Trump appointees would steer the bank toward higher interest rates and greater concern about inflation or let a potential Trump boom advance unconstrained.
Big fluctuations in the dollar could also shape a potential tension between Trumponomics and Fed policy. Economists believe a key element of a corporate income tax overhaul advanced by House Republicans, known as a border adjustment tax, would have the effect of creating a huge rally in the value of the dollar compared with other major currencies, perhaps 20 percent or more.
The Fed has been more focused than ever in the last few years on how its decisions ripple through the global economy. It held off on rate increases in 2015 and early 2016 in significant part because a rally in the dollar seemed to be destabilizing many emerging markets and fueling risks of a global slowdown. A stronger dollar also reduces inflation in the United States, which in turn makes the Fed more inclined toward caution on rate increases.
Mr. Trump has sent mixed messages on his views of a border adjustment tax, seeming to slap down the idea in a Wall Street Journal interview published this week. But if it looks as if policies on Capitol Hill are going to push the dollar up significantly.
Of course, that too could cut in the other direction. A stronger dollar doesn’t help with Mr. Trump’s goals of reducing the trade deficit, and just this week he has seemed to try to talk the dollar down.
Add up a week of new signals from incoming Trump administration officials and now Ms. Yellen’s speech, and it is looking like a distinct possibility that Ms. Yellen could wake up one morning in the year ahead to early-morning tweets directed her way, originating from 1600 Pennsylvania Avenue.
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