Bill Dudley, a research fellow at Princeton University’s Center for Policy makes a provocative argument about Federal Reserve policy in advance of the election:

U.S. President Donald Trump’s trade war with China keeps undermining the confidence of businesses and consumers, worsening the economic outlook. This manufactured disaster-in-the-making presents the Federal Reserve with a dilemma: Should it mitigate the damage by providing offsetting stimulus, or refuse to play along?

If the ultimate goal is a healthy economy, the Fed should seriously consider the latter approach.

The Fed’s monetary policy makers typically take what happens outside their realm as a given, and then make the adjustments needed to pursue their goals of stable prices and maximum employment. They place little weight on how their actions will affect decisions in other areas, such as government spending or trade policy. The Fed, for example, wouldn’t hold back on interest-rate cuts to compel Congress to provide fiscal stimulus instead. Staying above the political fray helps the central bank maintain its independence.

So, according to conventional wisdom, if Trump’s trade war with China hurts the U.S. economic outlook, the Fed should respond by adjusting monetary policy accordingly — in this case by cutting interest rates. But what if the Fed’s accommodation encourages the president to escalate the trade war further, increasing the risk of a recession? The central bank’s efforts to cushion the blow might not be merely ineffectual. They might actually make things worse.

(…)

[T]he Fed could go much further. Officials could state explicitly that the central bank won’t bail out an administration that keeps making bad choices on trade policy, making it abundantly clear that Trump will own the consequences of his actions.

Such a harder line could benefit the Fed and the economy in three ways.

First, it would discourage further escalation of the trade war, by increasing the costs to the Trump administration. Second, it would reassert the Fed’s independence by distancing it from the administration’s policies. Third, it would conserve much-needed ammunition, allowing the Fed to avoid further interest-rate cuts at a time when rates are already very low by historical standards.

I understand and support Fed officials’ desire to remain apolitical. But Trump’s ongoing attacks on Powell and on the institution have made that untenable. Central bank officials face a choice: enable the Trump administration to continue down a disastrous path of trade war escalation, or send a clear signal that if the administration does so, the president, not the Fed, will bear the risks — including the risk of losing the next election.

There’s even an argument that the election itself falls within the Fed’s purview. After all, Trump’s reelection arguably presents a threat to the U.S. and global economy, to the Fed’s independence and its ability to achieve its employment and inflation objectives. If the goal of monetary policy is to achieve the best long-term economic outcome, then Fed officials should consider how their decisions will affect the political outcome in 2020.    

Before addressing the merits of Dudley’s argument, it’s important to take note of both who Dudley is and what he’s saying. Prior to taking his current position at Princeton, Dudley was the head of the Federal Reserve Bank of New York from 2009 through 2018. He took up that position when the previous head, Timothy Geithner left to become Barack Obama’s Secretary of the Treasury and served in that capacity through the entirety of the Obama Administration and much of the first two years of the Trump Administration. As head of the New York branch of the Federal Reserve, he was effectively the second most influential member of the Federal Open Market Committee, the Federal Reserve Board committee that is largely charged with making the interest rate and other decisions that most directly impact American consumers and businesses. I point this out to make it clear that these ideas are coming from someone who had nine years of experience dealing with some of the most consequential economic decisions anyone in government can make, and that his experience dates back to the waning days of the Great Recession when Federal Reserve interest rate policy played an important, some would say crucial, role in preventing the economy from going over the cliff.

As Dudley well knows, Federal law basically obligates the Fed to set policy with two goals in mind. The first is to maintain stable interest rates and protect the value of the dollar worldwide. The second goal is the somewhat more difficult goal is to maintain economic growth, with a goal of aiming for what economists call “full employment.” These are sometimes contradictory goals, and the first is usually easier to accomplish than the second, but they are fairly straightforward and historically speaking, the Federal Reserve has done a fairly good job of achieving both of them. Of course that doesn’t mean perfection, as we learned during the inflation crisis of the 1970s, which was caused in no small part due to far too expansive monetary policy on the Fed’s part, and the Great Recession, the warning signs of which the Fed largely missed just like everyone else in government.

Now as far as what Dudley is proposing…….

The current Federal Reserve policy, which Fed Chairman Jerome Powell announced after the last FOMC meeting earlier this month, states that the Fed will take into account the impact of President Trump’s trade policies on the economy and that there may be additional interest rate cuts if it appears that those policies are slowing the economy down. Instead of doing this, Dudley argues, the FOMC should basically sit back and let the trade war do whatever it is going to do to the economy, even if that means tanking the economy. The reason for this? Because a recession or a slowing economy would probably make it less likely that President Trump is re-elected.

Slate’s Jordan Weisssman thinks Dudley is on precisely the wrong track:

Like many, the Fed’s ex-No. 2 is concerned that Trump’s trade war with China is undermining the U.S. economy—which it probably is—and thinks this “manufactured disaster-in-the-making presents the Federal Reserve with a dilemma: Should it mitigate the damage by providing offsetting stimulus, or refuse to play along?”

In other words: Should the Fed cut interest rates, as Donald Trump has been demanding, and risk encouraging him to escalate the trade war? Or should it leave them right where they are, even if it means the economy might fall into a recession?

To many, this is not a hard question. The Federal Reserve’s job, handed down by Congress, is to keep unemployment as low as possible while maintaining stable inflation. There is absolutely nothing in its mandate about discouraging politicians from embarking on a harebrained trade war. If Donald Trump wants to pursue a mutually destructive, tit-for-tat tariff battle with China, that’s his right as a duly-elected president. It’s the Fed’s responsibility to keep the economy afloat, or try to, in the meantime.

But Dudley doesn’t see things that way. He not only believes the Fed should leave rates be but that it should take a political stand on the issue. “Officials could state explicitly that the central bank won’t bail out an administration that keeps making bad choices on trade policy, making it abundantly clear that Trump will own the consequences of his actions,” he writes.

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It is hard to overstate what a tremendously dangerous concept this is. Dudley is not talking about a conflict between two equal branches of government. If the economy crashes and Democrats don’t want to pass a stimulus because it might help Trump, that would be crappy and inhumane, but it’d also fundamentally be politics. Voters could decide who to hold accountable. Here, Dudley is effectively talking about an economic coup staged by a group of unelected technocrats. He doesn’t seem to be worried about the implications of this idea, because he feels the president has already politicized the central bank. “I understand and support Fed officials’ desire to remain apolitical,” he writes. “But Trump’s ongoing attacks on Powell and on the institution have made that untenable.” But that is absurd! The best way for the Fed to show it is not a political institution is to not act like a political institution, and intervene to help the economy when circumstances obviously dictate it.

And if the Fed did actually try to sway trade policy, or an election, it could easily lead to the end of its cherished independence. Republicans and Democrats might start appointing and confirming reliable partisans to the Fed who would do their best to manipulate policy to maximize their party’s electoral advantage, kneecapping the economy when the other guys are in power and pumping it up when their own presidents are in office. (Trump already tried this with Stephen Moore and Herman Cain, who thankfully weren’t confirmed.) Or Congress might decide to simply blow up the Fed’s current structure altogether to make it more politically accountable to the White House.

Given that Dudley is a powerful former leader, his op-ed is not merely ill-conceived, but outright dangerous. Trump and plenty of other Republicans are already prone to seeing deep state conspiracies hellbent on taking down the president where they almost certainly don’t exist.

They are already prone, for that matter, to hate the Fed. But given his previous position, it is not a crazy leap to think that Dudley is voicing thoughts that other people inside the central bank have entertained. Ironically, by mouthing off on the internet, Dudley may be putting even more pressure on Powell & co. to go along with Trump, lest they look like they’re plotting regime change. But even if they do, this op-ed will probably live on as proof among the president’s supporters that the swamp is out to get him.

I’m 100% with Weissman on this issue. At least in its modern form since the end of World War Two, the Federal Reserve has strived to be as apolitical as possible, and it’s clear that this is exactly what was intended went the system was created a century ago. It’s the reason, for example, why the terms of the Chairman and the members of the Board of Governors are staggered and longer than those of a President unless that President serves two terms. It’s also why the law makes it difficult to remove the Chairman or other appointed Fed officials. The danger otherwise would be that monetary policy could end up being a far more partisan issue, something that would have an impact on interest rates, the value of the dollar, and the state of the economy.

Dudley is suggesting that Powell and the Fed should toss seventy years of that apolitical tradition to the side in a way that would involve the Fed putting its thumb on the scale in favor of one side in a political argument. That would complicate the operations of the Fed for years to come and, as Weissman notes, could lead to a situation where the Federal Reserve becomes a partisan pawn used by both political parties to support their respective agendas. In addition to being a bad idea, such a development would likely have consequences for the nation and would lead to chaos in worldwide financial markets that would make any downturn worse.

Fortunately, it seems unlikely that Chairman Powell and other Fed officials are not inclined to listen to ideas like this. That’s fortunate because it would be potentially disastrous if they did.