Trump’s perhaps correct critique of the Federal Reserve, explained

As a candidate for president in 2016, Donald Trump routinely alleged that the real state of the American labor market was much worse than official statistics said and also that the stock market was in a bubble because Fed Chair Janet Yellen was keeping interest rates low.

Upon taking office, Trump changed his tone rather quickly. Suddenly, official unemployment statistics became real and reliable, the stock market became a valuable indicator of the economy’s health, and Yellen was replaced not with one of the right-wing monetary policy hawks whom conservatives had touted during the Obama years but by Jerome Powell — a Republican with a broadly similar approach to Yellen on monetary issues.

What’s more, as Powell has continued Yellen’s approach of gradually raising interest rates, Trump has suddenly become an advocate of low rates. In July, he said he is “not thrilled” by rate hikes. In October, he said the Fed was “going loco.” He spent much of the past weekend tweeting in support of lower rates, and Tuesday morning cited a Wall Street Journal editorial as further support for his position.

This is a striking, hypocritical, and opportunistic turnaround for both Trump and the Journal (which editorialized back in 2016 that Yellen had been far too slow to raise interest rates) — but their new position happens to be the right one.

Trump’s arguments for dovish monetary policy are often incoherent or nonsensical. But the fact of the matter is that there is a decent-size body of economists, mostly though by no means exclusively on the left, who argue that at the end of the day, Trump is right — the Fed has been raising rates too quickly, not just this year but for decades, and in doing so has hurt workers and laid the groundwork for political dysfunction.

The mainstream view

First, though, it’s worth understanding the view that is still the consensus among most economists and that appears to have driven Federal Reserve policy thus far.

The short-term perspective here is that while ultra-low interest rates were an appropriate response to the ultra-high unemployment of the Great Recession, they are fundamentally aberrant and it is desirable to “normalize” monetary policy. The unemployment rate in 2018 is low, and it’s been on the low side for a couple of years now. So while you don’t want to raise rates so fast that you derail the economy, the time is right to take advantage of a healthy labor market to steadily increase rates until they are within the normal historical range.

Among other things, this has the advantage of making sure inflation stays low so there’s no need for hasty future anti-inflation moves.

The longer-term perspective here is that in general, curbing high inflation is really difficult. Politicians would always rather see a little more short-term growth and keep interest rates a bit on the low side. But if you always err toward “a little more growth” and “rates a bit on the low side,” then over time, more and more inflationary pressure builds up. Eliminating that pressure requires the extraordinary courage to deliberately inflict a recession — you often hear references to the “hard-won gains” of Paul Volcker’s inflation-whipping tenure as Fed chair — and avoiding that situation requires a politically independent Fed that’s able to resist the lure of low rates.

In this view, Trump is probably narrowly wrong to oppose a rate hike in December. But more than that, he’s cosmically wrong to be publicly lobbying for low rates. It wouldn’t necessarily be the worst idea in the world to skip the December hike and do it in the January 30 or March 20 meeting instead. But it would be terrible for the Fed to let people believe it was letting the president’s narrow political desire for stronger growth to influence its decisions.

The labor market is weaker than it looks

The contrary view is that this is all nonsense. Fighting inflation is easy, which is exactly why inflation has been so persistently low for so long. The real problem is that the labor market has been persistently weak for nearly 20 years, so much so that the unemployment rate has become an unreliable indicator — suggesting a longer period of low rates is probably warranted.

The simple argument against the idea that the low unemployment rate means we have a super-strong economy is to look at the share of prime-age workers — people between the ages of 25 and 54 — who have jobs. By this measure, the economy is doing okay but by no means great, and there’s still plenty of room for the workforce to grow back to the level it reached in 2000.

If you look at younger people, the case that there are more workers available looks even stronger.

Some of this, of course, is people going to school, which is a perfectly healthy development.

But we know that many students also work at least part time while they’re in school and that college tuition has gotten a lot more expensive. We also know that much of the recent growth in college attendance has come from low-quality programs (often run for profit) that have low completion rates and tend to leave students saddled with debt that is difficult for them to pay off.

So it seems wrong to consider the long-term decline in youth employment to be an entirely benign structural development driven by an increased love of schooling. At least some of the increase in schooling seems to be driven by young people pushed into low-quality educational options because the underlying job market has been difficult.

Further evidence of labor market weakness is that right now, wage growth — though certainly not terrible — is “meh” rather than “amazing,” as employers continue to find it not so hard to find workers to hire.

These signs of labor market weakness raise the question of why exactly there’s so much rush to raise interest rates. It’s true that the economy is no longer deeply depressed and we don’t urgently need low rates. But is there some reason we need higher rates?

Inflation is not a problem

Low interest rates are, fundamentally, pretty nice. If you need a loan to buy a house or a car or a major appliance, you can get one for cheap. If your business needs a loan to expand its office space or obtain more business equipment, you can get one for cheap. And those cheap durable goods and business investments aren’t just pleasant for the people who directly buy them; they also boost output and employment throughout the economy.

The reason you don’t just keep rates low forever is that too much easy money will lead to inflation.

But there’s no actual inflation problem in America today. The Fed is supposed to be targeting a 2 percent inflation rate, but once you strip out the price of volatile food and energy commodities, inflation has been consistently lower than that.

Of course, normal people care about food and energy prices too, and when they’re included in the mix, inflation has sometimes popped above 2 percent. But with these volatile commodities included, inflation has also tumbled well below 2 percent. Right now “core” inflation (the blue line) is not only slightly below 2 percent but is actually falling.

So it’s not really clear what the emergency is. Or perhaps more to the point, it raises the question of whose interests are really served by a determination to, in effect, fight inflation preemptively.

Labor scarcity is good for workers

The basic mechanism by which excessively easy monetary policy sparks inflation is supposed to be something like this: Faced with an acute shortage of workers, wages will start to rise faster than underlying productivity. Employers will thus have to raise prices to compensate for the higher pay, wiping out workers’ wage gains and leading to more demands for pay increases. The cycle simply continues, or even intensifies, devastating people with fixed incomes and ultimately wreaking havoc on investment decisions.

But as Binyamin Appelbaum recently argued in the New York Times, another thing that can happen when workers get pay raises in excess of productivity growth is that workers’ share of the national income pie grows. Instead, the trend in the 21st century has been for workers’ share to consistently decline as the economy has suffered through two recessions and zero periods of really strong labor markets.

Right now, unemployment is low and wages are rising.

Perhaps the Fed should just let them keep on rising for a bit, hoping that wage hikes will eat away at profit margins rather than spark inflation. Viewed through this lens, the determination to raise interest rates before inflation materializes looks more like a ploy to guarantee shareholders’ profits than an effort to stabilize prices.

At the very worst, an experiment with extended low interest rates could lead to a little inflation, and then the Fed could raise interest rates. But at its best, it could have broad structural benefits that go beyond a quirk burst in pay.

Imagining maximum employment

For the sake of convenience and clarity, economists like to conceptually separate “cyclical” economic issues (unemployed workers, idle machines, etc.) from “structural” ones (education and skill levels, the size of the working age population, etc.).

Reality, however, is messier than that.

Currently, for example, ex-convicts and the long-term unemployed face fearsome barriers to getting a new job that wouldn’t necessarily be a problem for a newly minted high school graduate. But a strong “cyclical” recovery that produces labor force shortages and pushes employers to take risks on reentering prisoners or people who’ve been jobless for years ends up being a “structural” remedy to the problem since, having been hired once, people are no longer on the margins of the labor force and are now capable of participating in a mainstream way.

Similarly, when forced to do so by strong cyclical pressures, employers may find ways to better accommodate workers with disabilities. Engaging in racial discrimination becomes more costly during a spell of full employment, and managers inclined to do it will find themselves falling by the wayside in favor of those ready to give opportunities to black and Latino workers.

More fundamentally, while in a weak labor market, the in-demand management skill is how to squeeze workers a little harder, in a strong labor market, skill at providing on-the-job training could become a hot management trend.

By the same token, prolonged labor market weakness has created a situation in which lots of people are employed in fundamentally low-value forms of labor. There’s been a huge proliferation of various kinds of on-demand delivery apps (for laundry, food, booze, etc.) that leverage a little bit of technology to connect consumers with low-productivity, low-paid irregular labor. In a hot labor market, those workers will transition into more normal jobs, and the technology workers making these apps will end up reemployed to solve more socially and economically profound problems that genuinely raise productivity rather than finding new ways to exploit loopholes in minimum wage rules.

Up from Trumpism

None of this is to say, obviously, that Trump has personally thought through all these issues or familiarized himself with the charts and graphs that could make the case for low interest rates persuasively. (I am, of course, happy to share even more charts with him if he’d like a briefing.)

But Trump’s willingness to openly campaign for lower rates and more economic growth against the central bank’s institutionalized conservatism is an example of a situation where breaking norms can be a good idea.

Barack Obama simply wouldn’t have done something like this, even though at times, his economic team believed that a more aggressive Fed would be good for the country. Yet while the norm of strong deference to central bankers appeared to make sense in the wake of the inflation of the 1970s, workers’ genuinely bleak experience with the 21st-century labor market really ought to have prompted a reevaluation of the thinking around these issues.

A systematic inflationary bias would be a bad way to do economic policy, but a systemic disinflationary bias is also bad. Paranoia about letting the unemployment rate get “too low” even in the absence of any actual inflation problem is a huge thumb on the scales in favor of incumbent business owners and against workers and innovation.

The next president shouldn’t imitate Trump’s slipshod opportunism, but the idea of pushing aggressively for growth-oriented monetary policy makes a lot of sense. And the fact that the gods of central banking haven’t come down from the sky to smite Trump for his impertinence ought to encourage future boldness.