Dissent at the Fed

September 30, 2019
Robert Samuelson

By Robert Samuelson


The battle to control the Federal Reserve is being waged on many fronts. There’s President Trump’s relentless tirades against Fed Chairman Jerome Powell — and Powell’s low-key rejoinders. There’s the clamor from investors (aka Wall Street) for easy credit to prop up stock prices. Some economists favor cheap credit to sustain low unemployment (3.7%). What’s been missing is a cogent challenge to the reigning consensus, which is this: Unless the Fed acts forcefully, the economy could fall into a recession.

That’s now changed.

In a recent speech at New York University, Eric S. Rosengren, president of the Federal Reserve Bank of Boston, gave a detailed criticism of Fed policy. At its last two meetings, the Federal Open Market Committee (FOMC) — the Fed’s main decision-making body — has cut interest rates a quarter point. Rosengren, along with Esther George of the Kansas City Federal Reserve Bank, dissented in both cases. (Dissenting in the other direction — favoring easier credit — was James Bullard, president of the St. Louis Federal Reserve Bank.)

This is significant. The political culture of the Fed emphasizes deference to the Fed chair and unanimity in most of its decisions. When dissents do occur, they usually reflect a fundamental disagreement. That is surely the case now.

To understand why, it helps to know a little “Fed-speak,” the technical jargon that economists and others use to discuss the economy. “Monetary policy” refers to the actions the Fed can take to ease or tighten credit. When policy is “accommodative,” it means that borrowers can find loans easily and that interest rates are, relatively speaking, low. When policy is not accommodative, it’s harder to borrow, and rates are higher or rising.

The interest rate that most concerns the Fed is the so-called Fed funds rate — the rate on overnight loans among banks. When the Fed raises or lowers this rate, long-term rates on bonds and mortgages are assumed to move in sympathy. Sometimes they do, and sometimes they don’t.

The crux of Rosengren’s complaint is that the Fed is running a highly loose policy when the economy has reached or exceeded “full employment.” The fed funds rate is now pegged between 1.75% and 2%, with another cut widely expected by year’s end. This upends traditional policy, which calls for lower rates when the economy is faltering and higher rates when markets are tight.

Here’s how Rosengren describes his objection:

“Having such an accommodative stance of monetary policy is unusual in what appears to be a fairly robust economy. Typically, the federal funds rate … [falls] during economic downturns. During a downturn, the costs of lowering rates are relatively modest, as fears of rising inflation are low and the concern is usually that too little credit being extended.”

Powell and others seem to fear that Trump’s trade wars, weak corporate investment and ongoing geopolitical turmoil (Brexit, Iran) will slow the economy and, perhaps, trigger a recession. This is where Rosengren departs from Powell and his Fed colleagues. In his NYU lecture, he noted that the U.S. economy is still growing at a 2% annual rate, roughly in line with its potential, despite all the problems.

“So the risks, while of concern, have not slowed the economy below its sustainable rate of growth,” he said. It doesn’t need more juice in the form of lower interest rates, which could raise inflation or fuel financial speculation. Note also that Rosengren rejects Trump’s policy, which is clearly aimed at winning reelection. It’s Powell on steroids — cut the Fed funds rate to zero and do it immediately.

The history here is relevant. In the past, the Fed has repeatedly waited too long before tightening its policies, and the consequences have been calamitous. In the 1960s and 1970s, the result was much higher inflation, peaking at about 13% in 1979 and 1980. In the early 2000s, the Fed’s easy-credit policies contributed to the devastating financial crisis.

Rosengren usefully reminds us of these failures. The main lesson: The pursuit of perpetual prosperity backfires. This happened before and could happen again. Take inflation. Over the past year, the “core” consumer price index has risen 2.4%, slightly higher than recent reports (the “core” CPI removes food and energy prices, which are exceptionally volatile).

Similarly, Rosengren thinks that some commercial real estate properties are overvalued, especially projects that embrace the “co-working” model of renting space to very small businesses. “This segment of the economy is likely to be particularly susceptible to an economic downturn,” Rosengren writes. There could be a chain reaction. Tenants default on their leases, leading to landlords defaulting on bank loans, leading to losses to banks, which hold mortgages on the buildings.

Rosengren may (or may not) be proved right. But he has raised the quality of debate and analysis to a new and better level.


(c) 2019, The Washington Post Writers Group