The president of the St. Louis Federal Reserve is confident the U.S. central bank will remain free from political interference under Donald Trump’s administration. Confident enough that he even still supports an increase in benchmark interest rates by the Fed at its next meeting in December.
“President-elect Trump’s transition team has said that it wants to protect Fed independence,” James Bullard told Handelsblatt in an exclusive interview. “I take them at their word.”
President-elect Trump has criticized Fed chairwoman Janet Yellen for keeping interest rates low, claiming that she’s under pressure from the Obama administration. He threatened to fire the Fed chair during the campaign, though Ms. Yellen’s tenure at the helm of the Fed continues until at least 2018.
It’s partly because the Fed’s board is nominated that Mr. Bullard doesn’t expect too much change under the president elect. The Federal Reserve’s policy committee consists of a dozen people, Mr. Bullard said, and Donald Trump will only fill a few seats.
“He would only gradually be able to put his stamp on the institution,” Mr. Bullard said. “I think you’ll have a lot of continuity in policy making in the meantime.”
For Mr. Bullard, that’s a good thing. History has shown what happens when politicians get too involved in monetary policy.
“I think very few people want to go to a Venezuelan- or Argentinian-style policy,” he said.
Below is a Q&A with the St. Louis Fed chair. The interview was edited for length and clarity and is not a full transcript.
Handelsblatt: Mr. Bullard, before the U.S. election, the Fed was heading for a rate hike in December. Is that still the plan or has the election of Donald Trump changed everything?
James Bullard: Barring a major surprise, I think I will support a rate increase at the December meeting. But the committee has not made a decision yet, and it will depend on what is going on at the time.
President-elect Donald Trump has promised more fiscal stimulus and tax cuts. How will that influence the Fed’s policy over the next year?
It would be difficult for the president-elect’s new policies to have an impact in 2017. It just takes a certain amount of time to get legislation passed, to get appointments made, and to get new policies in place. But possibly in 2018 and 2019 some of the policies could have an impact.
Which ones in particular?
There are five areas where the new administration clearly wants to do something. One is infrastructure spending. The second is regulatory relief. Another is changes to the U.S. tax code. And then you also have trade and immigration issues. The first three I think could be implemented relatively rapidly and could have an impact in 2018 or 2019. But immigration and trade would take longer, and would likely have longer-run impacts, but not impacts over a three- or four-year time horizon. I see the other three issues as being the more important from a monetary policy perspective.
If we were to see the results in 2018 and 2019, does that mean that monetary policy would have to be tightened in advance?
Unemployment is close to the level that the committee thinks is the natural level of unemployment. Inflation is a little bit low by our preferred measure, but it is coming towards the target and not very far away. So in some sense we have very good monetary policy right now. We have to see how this proceeds. But if we did raise interest rates it would be because good things were happening in the economy.
Since the U.S. election, it seems that markets are expecting a spike in inflation. Have markets gotten ahead of themselves?
There has been a bond rout since the election. But interest rates on 10-year U.S. government bonds are still not far away from where they were last year. Inflation expectations have come back as measured in TIPS markets. I think that is important, but they’re still not particularly high.
The dollar has also surged against the euro in the aftermath of the election. Some people expect it to reach parity with the euro. What is your opinion on that?
It has to be some kind of surprise in the monetary policy stance of the Fed or the European Central Bank that would lead to major changes in the exchange rate. And I am not sure we are at that point yet.
But the ECB will continue its loose monetary policy, whereas the U.S. will raise rates. So there will be a growing divergence between Europe and the U.S.
But markets expect that, so that is priced in. Only deviations from those policies might cause major changes.
Will interest rates return to pre-crisis levels any time soon?
We are in a different environment than before the crisis. In the 1980s and 1990s, we were in a higher real-interest-rate regime, and because of that we had a higher policy rate. But today we are in a low real-interest-rate regime. And if you look at real interest rates over the last 30 years, especially on government paper, they have been declining. It was not just the financial crisis. It started much before that and it has really been 30 or 35 years of declines in real interest rates. To suddenly predict that this is going to turn around is not the best thing to do.
What is the maximum to which U.S. interest rates could increase in this new environment?
If you look at the ex post one-year real rate of return on a U.S. Treasury, it’s about minus 130 basis points for the last three or four years. That’s extremely low by historical standards. The regime idea is that we’ll just stay where we are for now. At least for purposes of forecasting the next two or two-and-a-half years, I think you should just think that the real interest rate will probably stay very low. Where it’s going to go 10 years from now, I don’t know, but that isn’t really what we need to know for monetary policy purposes.
Let’s return to President-elect Trump. During his election campaign, he questioned the autonomy of the Federal Reserve. How worried are you about that?
The Fed has several features that have been designed in the law to protect the insulation from day-to-day politics. Part of that is that the terms of the governors in Washington are long – 14 years. So in principle there are supposed to be only a few appointments to be made at any one time. Also, the FOMC is a big committee because it is the governors plus the 12 presidents of the Reserve banks. You start with 17 people today, there are two openings, that’s a big committee. The presidents provide a lot of the institutional memory in the system, and of course they vote on a rotating basis. The president will have a chance to name new people, but he would only gradually be able to put his stamp on the institution. I think you’ll have a lot of continuity in policymaking in the meantime.
But there has been a political backlash against central banks all over the world. Are you not worried about that?
President-elect Trump’s transition team has said that it wants to protect Fed independence. I take them at their word. The actual Fed policy is pretty good right now. As I said, we’re very close to our inflation target, unemployment is low, interest rates are low. So I don’t think there is really the kind of cause for alarm that would trigger a major reform of the institution. If inflation was running at 15 percent as in the 1980s, that might have been the opportunity to say that this is not working and we have to rearrange things. That is not the case today.
Since the financial crisis, central banks have gained a lot of power worldwide. But with that has also come a tendency from politicians to question their independence. Have central banks maybe reached peak independence?
The history of macroeconomics is filled with examples of central banks that did not have independence from the political system and it did not work out well. We have current examples today: Argentina, Venezuela and Zimbabwe. When you allow politicians to have direct control, they tend to use monetary policy for electoral purposes. I think you need some modicum of independence from the political process. I think it’s a matter of degree rather than a switch that you would turn on or off. I think very few people want to go to a Venezuelan- or Argentinian-style policy.
But should central banks be more controlled?
In the U.S. this will be re-examined and it has been re-examined. And there are a couple of things we could do. We have talked about a monetary policy report in the U.S., which other central banks do. I think it would improve transparency. There are probably steps that we could take without legislative change.
So when you have more power, you also have to be more accountable and transparent?
I do not think we have gained power. We just did what we always did, but the crisis was just so big. But at least in the U.S. today that period is over; unemployment has come down below 5 percent, and inflation is not that low. It is really close to target and rising. The impetus for major changes seems to me to have dissipated.
Do you expect Donald Trump to stick to his words and replace Janet Yellen in 2018?
It is certainly up to the president. I would not prejudge that. There are two seats open now, so the administration could appoint people to those two seats. I do not have a sense of what the administration wants to do with those appointments.
President-elect Trump has accused the Fed of creating a false economy. Do you expect pressure from his administration to increase rates faster?
I don’t know. I will say that there were critics, let’s say five or six years ago, including myself, who warned that we were taking a lot of risk that could trigger high inflation. But the truth is, that has not happened. We do not have a lot of inflation in the U.S. or globally. It was right to worry about that, but in the end it has not happened. The critics, including myself, turned out not to be right.
You are now in favor of slower rate rises. Why have you changed your position?
Until late 2015 I argued that we had hit our targets and it was time to normalize rates. Then we made our first interest rate hike in December. Markets at the time interpreted us as once we had lifted off, we were going to continue to raise rates once a quarter regardless of what was going on in the economy. But at the turn of that year the data was weaker, and despite that the market expected us to continue with rate hikes. That created a toxic combination that led to huge sell-off in global markets in January and February. That has really changed my view.
So rates should be lower for longer?
The events early this year made me think that our plans to normalize were not compatible with the reality of the global economy. So, we changed our view (at the St. Louis Fed). We went to this regime-switching idea, and we now think we have a low-real-interest-rate regime. And for that reason we do not have to threaten global markets with 200 basis points of tightening. Instead, I think we can stay where we are, we’re just about neutral. I think we can go up in December and from there we have to wait and see if things like higher infrastructure spending improve the growth rate of the U.S. economy, and if they do, we can react appropriately.
Daniel Schäfer is head of Handelsblatt’s finance section and Jan Mallien leads Handelsblatt’s monetary policy coverage. Both are based in Frankfurt. To contact the authors: firstname.lastname@example.org and email@example.com