Ivan Fallon: US Fed policies show divergence with White House

Former chairman of the US Federal Reserve, William McChesney Martin, once famously described the role of the American central bank as 'taking away the punch bowl just when the party was really warmingShow more

A former chairman of the US Federal Reserve, William McChesney Martin, once famously described the role of the American central bank as “taking away the punch bowl just when the party was really warming up”.

Later today the process of cooling down president Donald Trump’s exuberant party will begin when Janet Yellen, the Fed chairwoman, raises its target interest rate by a quarter of a percentage point. It is only its third rate increase in 10 years but, more significantly, its second in three months, and Mrs Yellen is expected to signal that two more rate increases are on the way this year.

Just a month ago, a rate increase in March was reckoned as 40 per cent likely. Today it is virtually 100 per cent. In his first few weeks in the White House, Mr Trump painted a dire picture of economic stagnation and industrial decline, using some of the bleakest language ever used by a US president. Now, suddenly, instead of trying to prod a sluggish and inefficient monster into action, he faces the prospect of an economy that is in danger of overheating.

It is yet another surprise in this astonishing period of poor economic forecasting and political miscalculation. But it is a nice one for a change. The US economy is in good shape, even if Mr Trump has not quite got around to accepting that so early into his presidency – that would be to give president Obama, on whose watch it all started, too much credit.

Today’s move by the Fed shows how different the economic views of the Fed and the White House now are. The Fed believes the latest spurt of growth is unsustainable and should be reined in before inflation gets out of control. Mr Trump, on the other hand, wants to whip things along even faster by introducing his policy trifecta of tax reform, infrastructure blitz and deregulation, aiming for a growth rate of between 4 and 5 per cent, which has not been achieved since president Reagan’s time.

The blockbuster monthly jobs figures announced last Friday are only the latest batch of data that illustrates how strong growth is. The unemployment rate has dipped below 5 per cent, which my economics professors taught me was full employment. But jobs have continued to be created at an average of 215,000 jobs a month – more than twice the job growth necessary to keep pace with population growth.

There are reports of a tighter labour market, particularly in construction and building. In Texas, residential construction employment has reached levels not touched since before the 2008 financial crisis. Hourly earnings climbed by 20.3 per cent in the Texas construction sector between 2011 and 2016, and the National Association of Homebuilders says that 82 per cent of builders now regard the cost and availability of labour as their primary concern.

All across America, adults who gave up on finding jobs are returning to work, stock markets are booming, and all the measures of consumer and business confidence are remarkably buoyant. The US expansion is sturdier and more broadly based than it has been for a decade.

That is all good stuff for Mr Trump and the White House. But Fed officials now seem to believe that the US economy is already nearing its full economic potential and it should begin, sooner rather than later, to slip that punch-bowl out of sight.

The trick now is to get the right balance between fiscal and monetary policy so that growth keeps going but inflation stays under control. That actually may already be happening: several senior Fed officials have recently made public comments suggesting their growing confidence – and unanimity – that the economy can handle tighter money, the first time that has been heard since the financial crisis about a decade ago.

“Recent developments suggest that the macroeconomy may be at a transition,” said Lael Brainard, a senior Fed governor and a famous dove on interest rates. “Full employment is within reach, there are signs of progress on our inflation mandate, and a favourable shift in the balance of risks at home and abroad.”

Her point is that we are at a major sea-change in the history of US monetary policy, and the years of artificially low interest rates and loose monetary policy are drawing to an end. In the view of Mohamed El Erian, the chief economic adviser to Allianz and author of The Only Game in Town, today’s Fed statement will signal “an important evolution in its policy approach aiming for a beautiful rate normalisation”.

Ivan Fallon is a former business editor of The Sunday Times and the author of Black Horse Ride: The Inside Story of Lloyds and the Financial Crisis.

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