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Sept. 19, 2019, 12:53 p.m. EDT

Powell’s dilemma: Easing offsets trade uncertainty, but invites more of the same from Trump

To Trump’s dismay, the Fed won’t join global race to the bottom

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By Carmen M. Reinhart and Vincent Reinhart

Mark Wilson/Getty Images
Federal Reserve Board Chairman Jerome Powell often has a haunted look.

CAMBRIDGE, Mass. (Project Syndicate) — Once a year, the leadership of both the European Central Bank and the U.S. Federal Reserve go to the mountains for policy enlightenment. The ECB conducts a forum every June in Sintra, a town in the foothills of the eponymous Portuguese mountain range. And the Fed convenes in late August in Jackson Hole, Wyo., for the Kansas City branch’s economic symposium.

In retrospect, this year’s remarks from on high by ECB President Mario Draghi and Fed Chair Jerome Powell provide insight into the global outlook and the two banks’ recent policy actions, which have been coincident, but not coordinated.

Fed lowers interest rate by a quarter-point, and is open to the idea of more easing

if Powell succeeds, Trump will not bear the cost of his words and actions. This will invite more of the same.

In Jackson Hole, Powell named the challenge to the global economic outlook, not personally (President Donald Trump), but operationally: Heightened trade uncertainty , he said, presented a new drag on aggregate demand.

Pitfalls of real-time policy making

Back in 2018, most Fed officials believed that 3% annual real gross domestic product growth was unsustainable, because resource utilization was already taut. That assessment led the Fed to hike the policy interest rate by a quarter point four times.

That episode demonstrates the pitfalls of real-time policy making. One year later, the Bureau of Economic Analysis trimmed almost half a percentage point from GDP growth for 2018, and the Bureau of Labor Statistics prepared to revise downward its estimate of monthly employment gains.

Among the mechanisms by which an increase in interest rates slows aggregate demand is the foreign-exchange market. When the Fed is set on tightening as other central banks hug the effective lower bound of their nominal policy rates, the dollar’s value /zigman2/quotes/210673925/realtime XX:BUXX -0.44%   /zigman2/quotes/210598269/delayed DXY -0.42%  rises.

Essentially, dollar appreciation is a channel through which policy makers “donate” domestic economic strength to U.S. trading partners that now have weaker, more attractive currencies. With the ECB’s policy rate distinctly negative and its asset-purchase program running out of steam, Draghi especially appreciated the gift of easier European financial conditions last year.

Of course, the transfer of domestic economic strength by an independent agency, the Fed, displeased the chief executive, and withering criticism ensued.

Less concrete will be poured

But it was not Trump’s carping about dollar appreciation that led the Fed to change course. Rather, Trump’s trade policies elevated uncertainty about investment and growth. Investment in long-term capital is always risky for a business. When doubt about such an investment emerges before concrete is poured, less concrete will be poured.

By early 2019, the Fed viewed this new economic headwind as obviating the need to continue raising the federal funds rate. As the year unfolded and the trade winds intensified, Fed officials switched course and began to ease policy.

Some economic mechanisms, however, are asymmetric.

XX : WSJ Index
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US : U.S.: ICE Futures U.S.
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