This commentary was written by Dr. Daniel Thornton of D.L. Thornton Economics.

The Fed Has Surrendered Its Independence  - 09.19.2018 FED cartoon

In a recent essay, I wrote the Federal Open Market Committee’s (FOMC’s) decision to reduce its target range for the federal funds rate 25 basis points on June 31 was mistake. Powell attributed the decision to “trade policy developments” and “concerns about the strength of the global economy,” two things the effects of which monetary policy cannot possibly ameliorate. Moreover, virtually every FOMC participant knows this.

Consequently, I suggested this decision raised concerns about the Fed’s independence, especially, in light of the fact that the President had been berating the Fed for not reducing the target for several months before the announcement. I ended the essay with the statement: “If more rate cuts come while the labor market and economy remain strong, it will be clear that the Fed caved in to the President and the Fed’s independence may be no more.”

The FOMC cut the target 25 basis points on July 31 and again yesterday, October 30, in spite of the fact that the FOMC’s economic condition statements for the last three meetings are nearly identical to the statements for the previous four meetings, when the FOMC took no action. Indeed, one might have expected the FOMC to reduce the target at its March meeting when the statement included the sentence “recent indicators point to slower growth in household spending and business fixed investment.” But it didn’t.

Many FOMC participants have argued the FOMC’s policy decisions are “data dependent,” meaning the FOMC will respond only when there are signs that the economy is weakening. According to the Fed’s own analysis, this isn’t the case now and hasn’t been all year. In an interview with Bloomberg yesterday, former Philadelphia Federal Reserve Bank President, Charles Plosser, criticized the FOMC for poor communication because its recent actions don’t align with its economic outlook. He found it difficult to know whether the cuts were made to placate the market or the administration.

It is understandable that Plosser would be reluctant to say the Fed has taken these actions solely to appease the President. But this is the most plausible explanation. Most, if not all of the FOMC participants, know that funds rate cuts cannot ameliorate the effects of Trump’s trade war or slowing global economic growth. Hence, Powell’s statement that the actions were taken as insurance against these events is not credible.

Even the devout monetary policy dove, Alan Blinder, recently noted, there are no signs of a recession and monetary policy can’t “undo the damage from tariffs.” He also noted that a 50-basis point rate cut (now 75-basis points) doesn’t “buy you much insurance.”

It is highly unlikely that the FOMC would cut rates to placate the market. The market didn’t want the Fed to raise rates, but the FOMC did it anyway. Responding to market pressures is a no-win proposition. What helps the stock market hurts the bond market and those living on fixed incomes. For a long time now, the FOMC has been communicating its intentions before taking actions in order not to surprise the markets or the public generally. 

The logical conclusion is the FOMC has reduced its target 75 basis points in an effort to placate the President. It won’t work! Trump won’t be satisfied until the FOMC reduces its policy rate to zero. When this does nothing to “undo” the deleterious effects of his trade war, he will want the Fed to pursue a negative nominal interest rate policy. But as I noted in an essay I wrote last year, there is nothing positive about negative nominal interest rates.


This is a Hedgeye Guest Contributor piece written by Dr. Daniel Thornton. During his 33-year career at the St. Louis Fed, Thornton served as vice president and economic advisor. He currently runs D.L. Thornton Economics, an economic research consultancy. This piece does not necessarily reflect the opinion of Hedgeye.