In light of the interest rate hike on Wednesday, it is clear that the Fed and the President have different ideas about the economic state of our country.
When it comes to smoothing out a business cycle, the government has two “toolboxes” it can work from to correct any abnormalities. The first is fiscal policy, the umbrella under which taxes and government spending fall. It’s twin is monetary policy, which is controlled by the Federal Reserve Bank. It has influence over the money supply and interest rates.
When the two work together, problems like recessions or high inflation are brought back under control. The recent rate hike may seem commonplace, but the context and implications behind it are of monumental proportions.
Why Increase Rates?
When the Federal Reserve raises interest rates, it is to cool down an economy that may start to expand too quickly so as to prevent high inflation. When interest rates are low, more businesses take out loans or otherwise invest. More firms open, so unemployment is typically low as well.
However, when too many firms increase their production, then more workers have more money burning a hole in their pocket. Suddenly there’s a surplus of money chasing a relative shortage of goods, with the only means of correction being higher prices. Then, because prices have risen, employees demand higher wages and a downward spiral begins.
While increased output is desirable for any nation, it is commonplace to increase rates to prevent any wild swings and ease us back down before we push too far too fast. Therefore, Wednesday’s rate hike would suggest that we are in an expansion, approaching the peak of our business cycle.
The White House would appear to disagree. President Trump’s campaign argued and emphasized that our economy is actually underperforming. Although only two months into his presidency, he has laid out a comprehensive short-term stimulus plan, turning heads with such components as decreased environmental regulations, a 20% cut in corporate taxes and large government spending projects.
These fiscal policy actions would serve to increase consumption and investment – very useful in a recession – and are contradicted by the Fed’s action.
A House Divided
Some view the Fed’s action on Wednesday to be politically motivated in an attempt to undermine Trump’s presidency. While Janet Yellen, chairperson of the Federal Reserve was appointed under the Obama administration, it may be too hasty to point fingers. The Fed is designed to be independent of governmental influence and congressional oversight, and on the hole their work is widely considered nonpartisan.
The rate hike is likely a balancing force in response to the stimulus plan projections, but more likely than not for the good of the economy as a whole. The Federal Reserve Board believes that the economic projections are to bring us too close to a high rate of inflation, an outcome we would all like to avoid.
Needless to say, speculators are confused as to which cues to pick up on. The Fed presses the brakes as the President hits the gas pedal. Clearly one of the two bodies has the wrong idea, but which one remains unclear in light of the business cycle debate.
Continued Recovery or Peak?
The best answer is, it’s hard to tell. A typical iteration of the business cycle from trough to trough is about 6 years. With the Great Recession striking in 2008 and reaching critical mass in late 2009, that data suggests that we are overdue.
With that being said, due to the severity of the Great Recession in comparison to those before it, some analysts predict and have observed an unusually long recovery, meaning it could still be a few years before we see another recession.
With President Trump’s agenda turning lefty-loosey and Janet Yellen’s turning righty-tighty, the net result is likely a wash, with a decrease in business investment but an increase in spending.
Only time will tell.