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Fed Chair Janet Yellen holds a news conference following a meeting of the Federal Open Market Committee March 15, 2017 in Washington, DC.Chip Somodevilla/Getty Images

The Federal Reserve has set itself on a collision course with Donald Trump.

The brewing conflict rests on two radically different views of U.S. prosperity. In its cautious, technocratic way, the Fed reiterated on Wednesday that the country's economic machine is ticking along nicely and nearing its productive potential.

In stark contrast, Mr. Trump has maintained since his election in November that he inherited an economic "mess" that demands big tax cuts and sizable stimulus to put right.

The Fed's position implies the economy is running hot enough to require a series of interest-rate hikes over the next year to cool it off. Higher rates could prevent a potentially damaging outburst of inflation – and maybe, just maybe, rein in an overenthusiastic stock market.

However, those who accept Mr. Trump's viewpoint are likely to object strongly to any attempt to put brakes on the economy. Instead, they have spent the past few months arguing for tax cuts, new trade deals and a war on regulation "to return to 4 per cent annual economic growth," in the words of the White House website.

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U.S. administrations have clashed with the Fed in the past, but rarely, if ever, have the two sides appeared so far apart. If both stick to their positions, the next year will feature a struggle between Trumpian stimulus and Fed-driven restraint.

"The simple message is that the economy is doing well," Fed chair Janet Yellen told a news conference on Wednesday after the central bank announced it was hiking its benchmark interest rate by a quarter of a percentage point, to between 0.75 and 1.0 per cent. The Fed continues to expect two more rate hikes this year.

Ms. Yellen said the decision to hike wasn't based on speculation about what Mr. Trump might do, but rather on the Fed's assessment of how the economy is performing right now. "It's doing nicely," she said.

She added that she did not see any necessary conflict between Fed policies and Mr. Trump's agenda. She stressed that she would welcome faster growth – but only if price stability can be maintained.

However, what she didn't say is that the U.S. economy already appears to be operating close to its potential. Unemployment, for instance, has fallen to 4.7 per cent – pretty close to full employment by most estimates.

As a result, a dollop of further stimulus could easily result in a burst of unwanted inflation. The Fed's preferred gauge of inflation has already ticked up to 1.9 per cent, just a hair under the central bank's 2-per-cent target.

By the Fed's reckoning, the economy should grow 2.1 per cent in 2017. That is very close to the 2.2 per cent that it believes is the upper boundary for sustainable long-term growth.

To be sure, growth of that magnitude looks dismal compared to previous decades when far higher rates were common. But Fed economists argue that slowing population growth and plodding productivity improvements have significantly lowered the economy's potential for speedy expansion.

Mr. Trump begs to differ, as his 4-per-cent pledge demonstrates. If the president continues to aim for faster growth but his efforts are offset by Fed rate hikes in months ahead, the tension in Washington will swell.

One result could be a radical reshaping of the Fed.

Like most other central banks, it prides itself on being free of political interference. Its independence leaves it free, in theory, to regulate the economy in the long-term interests of the nation, rather than serving the electoral whims of whichever party happens to be in power.

But the Fed has become a favourite whipping boy of the Republican party. During the election campaign, Mr. Trump slammed Ms. Yellen for keeping rates so low. He charged she was putting a lid on borrowing costs to benefit the Obama administration.

The Tea Party wing of the Republican party also has had the Fed in its sights. Some members of Congress have backed a campaign to "audit the Fed" and subject the central bank's decisions to greater public scrutiny. Others have demanded the Fed operate according to formulas, such as the so-called Taylor rule, that would automatically set interest rates based on factors such as inflation and unemployment.

Mr. Trump will have the opportunity to refashion the central bank over the next year and a half. Ms. Yellen's term as chair of the board of governors of the Federal Reserve System expires on Jan. 31, 2018, and Stanley Fischer's term as vice-chairman ends a few months later, in June, 2018. In addition, two seats on the seven-member board of Fed governors are currently vacant and another one will come open this summer.

If Mr. Trump appoints loyalists to all those positions, the Fed could suddenly start sounding like an echo chamber for the White House. But if the market isn't impressed by his appointments, they could begin to lose faith in the world's most powerful central bank. That could have consequences too disruptive even for Mr. Trump.

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