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U.S. Federal Reserve may stall Trump’s plans for economic growth

The Marriner S. Eccles Federal Reserve building stands in Washington in November. Federal Reserve Chair Janet Yellen told lawmakers on Thursday that she intends to stay in the job until her term expires in January 2018 while extolling the virtues of the Fed's independence from political interference.

Andrew Harrer/Bloomberg

Legend has it that the Federal Reserve used to surprise people.

Of course, that was back in ancient times, when inflation still roamed the Earth and central bankers delighted in occasionally body slamming the economy into submission.

How times have changed. When the Fed announces on Wednesday that it is bumping up rates for the second time in a decade, the next sound you hear will be a continent yawning.

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In fact, any move except a modest quarter-percentage-point hike in the federal funds rate would stun markets. Today's central bankers pride themselves on signalling moves well in advance, and Fed Chair Janet Yellen and others have taken great pains in recent weeks to indicate they believe the time is ripe to start slowly ratcheting up borrowing costs.

But despite the low potential for surprise, this week's announcement still possesses historical significance. For the Fed, it qualifies as 1 AD: its first official action After Donald.

As the age of Trumponomics dawns, one of the world's most cautious, buttoned-down institutions must work with the most unpredictable president-elect in U.S. history.

What could possibly go wrong? One possible point of contention is Mr. Trump's vow to boost U.S. economic growth from its current tepid pace of about 2.6 per cent a year. He wants to propel it to 4 per cent.

The last time the economy expanded at such a rate was back in 2000, so the president-elect has set an ambitious target – and here's the catch: The Fed may not be a willing ally.

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Given its mandate to keep inflation under control, the central bank would feel pressure to start raising rates aggressively if Mr. Trump's grand stimulus plans showed signs of overheating the economy. The administration and the central bank would then wind up working at cross purposes.

Mr. Trump, who has been known to interfere in a thing or two, might not take kindly to that arrangement. The Fed, which is supposed to be non-political and non-partisan, could find itself in a battle to preserve its independence.

Mr. Trump has already fired some opening salvos. During the election campaign, he lambasted Ms. Yellen for keeping rates so low. He declared she should be "ashamed" of what her policies were doing in terms of inflating stock prices to unrealistic levels and accused her of sticking to a low-rate agenda for political reasons – as a way to support President Barack Obama's legacy.

The personal attacks on a Fed chair were unprecedented by a presidential candidate. These days, though, Mr. Trump has every reason to cheer for a continuation of lower-for-longer monetary policy.

He doesn't want to share in the blame if an aggressive series of rate increases over the next couple of years were to kneecap the stock market. His plans to boost growth would only be aided by rock-bottom borrowing costs.

That's where things get sticky, though. Consider the situation facing Ms. Yellen and other Fed decision makers.

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Unemployment in the United States has plunged to 4.6 per cent, the lowest level since August, 2007, just before the financial crisis. Initial jobless claims are running at 40-year lows. This is not an economy that obviously needs a big dollop of additional stimulus.

Yet that is exactly what Mr. Trump is proposing. He wants tax cuts and infrastructure spending to spur growth and revive U.S. manufacturing.

If he is serious about achieving 4-per-cent growth, his ambitious plans are going to run smack into some structural limitations. The biggest is an aging work force that is retiring in large numbers. As a result, the working-age population is barely expanding.

Economic growth comes from only two sources: more workers or more productivity. Combine the lack of new workers with dismal productivity growth in recent years and it's difficult to see how the U.S. economy can grow at a sustained pace of much more than 3 per cent a year.

Efforts to push it higher might easily result in an outburst of inflation. To be sure, the Fed could simply watch from the sidelines for a while. Price increases, excluding food and energy, are still a hair below the central bank's target of 2 per cent.

But if Mr. Trump insists on strong measures to spur even more growth, the Fed could be forced to move quickly to tamp down the resulting surge in prices. It might even, perish the thought, have to surprise people.

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About the Author

Ian McGugan is a reporter with The Globe and Mail's Report on Business and has been writing about investing, economics and business for more than 20 years. He joined the Globe and Mail in 2010. He has been executive editor of Canadian Business magazine and founding editor of MoneySense magazine. More

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