Hawks, Doves and Lapdogs

The next Fed chair will be an obedient partisan

Yesterday’s CPI report looked fairly tame on the surface, but if you look at the details it showed clear signs that Trump’s tariffs are starting to drive up prices. And private surveys suggest that there’s a lot more inflation in the pipeline. For example, look at S&P Global’s Purchasing Managers’ Index for manufacturing, which shows the percentage of firms reporting higher prices. A higher number almost always points to higher official inflation ahead, and right now it’s definitely telling us that tariffs are about to hit hard:

Why aren’t we seeing the full effects of the tariffs in official statistics? For the record, I don’t believe Trump officials are cooking the books — yet.

That’s not to say that they won’t at some point, and there’s a good chance that they will. But so far what we’re probably seeing is a combination of ordinary lags and the temporary effects of the TACO (Trump always chickens out) narrative. Buyers get pissed off at sellers when prices rise, so sellers who don’t want to lose market share have an incentive to hold prices down despite higher costs if they think the Trump tariffs will come back down in a few weeks.

I, however, am a TACO skeptic. I think Trump really is a Tariff Man who will keep us at Smoot-Hawley-level tariffs indefinitely, and businesses will eventually realize that and raise prices accordingly.

And then what? Clearly, we shouldn’t expect Trump to admit that his tariffs are raising prices, or even to admit that prices are rising. What we can expect is that he will keep putting pressure on the Fed to cut interest rates. I don’t think he’ll manage to push Jerome Powell out before next May, but as I wrote last week, whoever he picks after that will do his bidding.

Bloomberg has an interesting article about Kevin Warsh, one likely choice — although a newer article suggests that Kevin Hassett, whom nobody suspects of having any independent principles, may be in first place. The article expresses puzzlement over Warsh’s support for rate cuts now, despite above-target inflation, when he was a big advocate of higher rates in the aftermath of the global financial crisis. How did such a monetary hawk suddenly become a monetary dove? But one of the people the article quotes hits the nail on the head:

“He was the one for years complaining about inflation when it didn’t exist, and has kind of changed his tune,” said Stephen Myrow, who runs Beacon Policy Advisers and crossed paths with Warsh while working in the Bush administration.

“People will like that he has the resume and can play the part, but he clearly doesn’t have any core convictions,” Myrow said.

Indeed. Back in 2010 I went through one of Warsh’s hard-money speeches, and found it completely incoherent. I think what I wrote may be worth reposting:

The bottom line of Warsh’s speech — although expressed indirectly — is that it’s time for fiscal austerity, even though the economy remains deeply depressed; and no, the Fed can’t offset the effects of fiscal contraction with more quantitative easing. In short, the responsible thing is just to accept 10 percent unemployment.

And why is this the responsible thing? On fiscal policy,

market forces are often more certain than promised fiscal spending multipliers

Um, but those market forces are currently willing to lend money to the US government at an interest rate of 3.05 percent. But never mind:

unanticipated, nonlinear events can happen

So it’s these “unanticipated, nonlinear events” that are “more certain” than the direct effects of fiscal policy? I’m confused.

And on monetary policy,

The Fed’s institutional credibility is its most valuable asset, far more consequential to macroeconomic performance than its holdings of long-term Treasury securities or agency securities. That credibility could be meaningfully undermined if we were to take actions that were unlikely to yield clear and significant benefits.

OK, but why, exactly, does it help the Fed’s institutional credibility to do nothing to help a deeply depressed economy?

The point here is that Warsh’s argument basically rests on assertions not about what markets are saying now, but about presumed market reactions to policy. And these assertions about how markets will react are

(a) not based on any actual evidence

(b) actually assume that markets will behave irrationally

This goes for both fiscal and monetary policy. Again, right now the bond market doesn’t seem worried about US solvency. And rationally, stimulus spending shouldn’t change that view: with the long-term real interest rate well below 2 percent, current borrowing has only a trivial effect on the long-run state of the budget.

You may say that markets will see short-run austerity as a signal of our willingness to make long-run sacrifices; but why? What the United States needs to do in the long run, mainly controlling health care costs and increasing revenue, has nothing to do with the question of whether we have a second stimulus package.

On monetary policy: again, the large expansion of the Fed’s balance sheet so far doesn’t seem to have worried markets: right now, the 10-year TIPS spread is 1.9, showing no sign of exploding inflationary expectations. And for that matter, a rise in inflation expectations would actually be a good thing right now, encouraging more spending — unless you believe that markets will somehow react badly, for reasons not specified, to the Fed’s impaired “credibility” defined as … well, I’m not sure what.

So what we’ve got here is an assertion that bad things will happen if you do certain things, without either any evidence to that effect or any explanation of why those things should happen. Yes, maybe bond markets will punish us if we don’t slash spending right now; also, maybe we’ll have bad luck if we step on cracks, or fail to turn aside when Basement Cat crosses our path. But why does this pass for judicious policy discussion?

So neither Warsh’s call for tight money back then nor his call for lower rates now (and his harsh but vague demand for “regime change” at the Fed) make any sense if you’re looking for an economic rationale. They make perfect sense, however, if you see Warsh as neither a hawk nor a dove but rather a lapdog — someone who uses impressive-sounding jargon to rationalize whatever monetary policy he thinks serves the G.O.P.’s political interests or, these days, Trump’s whims.

If Warsh does get the nod, many on Wall Street will probably be reassured, believing that he’s a serious person. But he isn’t and never was. The Fed will soon be as politicized as everything else in the federal government.

MUSICAL CODA