Donald Trump ' s Real Influence on Fed Policy

A lot of ink was spilled last month over President Trump ’s criticism of the Fed raising interest rates. Observers worried that those criticisms meant the President was prepared to directly meddle with U.S. monetary policy. But so far, at least, there ’s no evidence that any such meddling has occurred.The Trump administration ’s fiscal policies have, however, indirectly influenced the Fed, by straining it’s post-crisis operating system. In particular, the large federal budget deficit has been putting upward pressure on short-term market interest rates; and those rising rates have, in turn, put pressure on the Fed’s “floor” system of monetary control. If the deficit continues to grow, as is expected, it might even bring an end to that system.To see why, a quick review of the floor system ’s workings is in order.The Fed ’s Floor SystemIn one of its more important but underappreciated crisis-era monetary policy innovations, the Fed switched from a corridor-like operating system to a floor operating system. It did so by paying interest on excess reserves (IOER) at a rate higher than going short-term market interest rates, thereby pushing banks onto the perfectly elastic region of their reserve demand curve. The change allowed the Fed to add reserves to the banking system, as it had been doing through various emergency lending programs, without loosening its monetary policy stance by causing the effective fed funds rate to fall below its target. Changes to the ...
Source: Cato-at-liberty - Category: American Health Authors: Source Type: blogs