Jerome Powell’s Dilemma
There is a reason that the US Federal Reserve chair often has a haunted look. Probably to his deep and never-to-be-expressed frustration, the Fed is setting monetary policy in a way that increases the likelihood that President Donald Trump will be reelected next year.
CAMBRIDGE – Once a year, the leadership of both the European Central Bank and the United States Federal Reserve go to the mountains for policy enlightenment. The ECB conducts a forum every June in Sintra, a town in the foothills of the eponymous Portuguese mountain range. And the Fed convenes in late August in Jackson Hole, Wyoming, for the Kansas City branch’s economic symposium. In retrospect, this year’s remarks from on high by ECB President Mario Draghi and Fed Chair Jerome Powell provide insight into the global outlook and the two banks’ recent policy actions, which have been coincident, but not coordinated.
In Jackson Hole, Powell named the challenge to the global economic outlook, not personally (US President Donald Trump), but operationally: heightened trade uncertainty, he said, presented a new drag on aggregate demand. Back in 2018, most Fed officials believed that 3% annual real GDP growth was unsustainable, because resource utilization was already taut. That assessment led the Fed to hike the policy interest rate by a quarter point four times.
That episode demonstrates the pitfalls of real-time policymaking. One year later, the Bureau of Economic Analysis trimmed almost half a percentage point from GDP growth for 2018, and the Bureau of Labor Statistics revised downward its estimate of monthly employment gains. Among the mechanisms by which an increase in interest rates slows aggregate demand is the foreign-exchange market. When the Fed is set on tightening as other central banks hug the effective lower bound of their nominal policy rates, the dollar’s value rises. Essentially, dollar appreciation is a channel through which policymakers “donate” domestic economic strength to US trading partners that now have weaker, more attractive currencies. With the ECB’s policy rate distinctly negative and its asset-purchase program running out of steam, Draghi especially appreciated the gift of easier European financial conditions last year.
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