Some Thoughts On… Falling into Disrepute

The current administration is taking a strong view of the President’s power guided by the Unitary Executive Theory.  Claiming expansive powers, Trump removed the Commissioner of the Bureau of Labor Statistics claiming, she had “rigged” the employment number. This week he removed one of the Governors of the Federal Reserve.

What are these economic organizations and why should we care about them?

The Bureau of Labor Statistics (BLS) is an independent government agency under the Department of Labor that is responsible for collecting inflation and employment data from all regions, cities and demographics of the United States. Their reports are non-partisan and objective indicators of the welfare of the economy.

The Federal Reserve (The Fed) is an independent, quasi-government agency responsible for US monetary policy.  The dual mandate of The Fed is to keep inflation low and employment high.  This is challenging as two goals are typically at odds with each other, e.g. if employment is high, then people tend to spend more money which leads to high inflation. 

The Fed walks a tightrope between employment and inflation, by changing the demand and supply of a key interest rate called the Federal Funds Rate (FFR) – the rate at which banks borrow reserves from each other. Reserves for a bank are similar to an individual’s savings account; it is the money they have in their vaults which they have not loaned out.  Banks borrow reserves from other banks on a regular basis. These loans are considered very safe and are usually paid back in a few days.

The Fed influences the demand and the supply for reserves which in turn impacts the FFR.  If they believe the economy is too hot (inflation is increasing), they decrease demand for reserves (decrease demand for ‘savings’) which lowers the FFR.  A lower FFR means banks can borrow reserves at a lower cost and the banks eventually bring down the interest rate on loans they make to consumers, such as mortgages and business loans.  The Fed doesn’t directly control interest rates on loans; it relies solely on its influence over the FFR.

The decision to raise or lower the FFR is made by the Federal Reserve Open Market Committee (FOMC) composed of 12 individuals.  Seven of the members are appointees, who are nominated every two years by the US President for a 14-year term.  The other five are private sector individuals who head up the regional offices of The Fed.  The system is built so partisan interference should not impact independence of the organization.

Trump is attempting to break down the independence of these agencies and place them under his influence. Why does their independence matter?

-              Employment and inflation numbers controlled by a President could be unreliable and would create uncertainty for consumers and businesses.  If an administration can “cook” the numbers so they look more favorable, then people and companies will lose trust in them.  Historically, estimates from BLS were considered gold-standard, and many global institutions use them for research, forecasting and teaching. Unreliable numbers mean citizens and organizations cannot plan appropriately. Hiring decisions, wage and salary increase, loans by banks are all influenced by reliable estimates of inflation and employment.

-              A President that controls the interest rate can manipulate elections.  Consistently, the economy is the biggest issue influencing voters. If the economy is doing well, voters keep the incumbent party in power. By forcing a lower FFR, twelve 12 months before an election, the Fed would spur the economy in time for the 2026 mid-term elections. Similar to a country-wide adrenaline shot, a lowered FFR rate will lower rates for other loans, enticing people and companies to borrow. Companies will borrow money to build factories or expand business, leading to more hiring and higher employment.   Simultaneously borrowing money to buy houses, or cars or appliances, will lead to higher demand for goods, higher prices and higher inflation.

-              A President that controls the interest rate also controls the value of the US dollar. Interest rates in the US and the stability of the dollar, are primary reasons international individuals and companies invest in the US and hold US currency.  Knowing the system is being manipulated for political reasons, foreign investors will trust the US less. Demand for the dollar will go down, and the dollar will be weaker against other currencies.  In the short run this means it will be more expensive for US-based people to purchase foreign products or visit other countries.  In the long run, if there is declining confidence in the dollar and the Federal Reserve, then other currencies, like the Chinese Yuan or Euro, could replace the dollar as the default currency for trade and the US will lose status in the global system.

It has taken 70 years, since the end of World War II, for institutions like the BLS and The Fed to gain their global reputation as world-leading organizations due to their independence and rigor. It would be a devastating hit to the world economy to see them and the US fall into disrepute over the next four years.