Federal Reserve Chair Jerome Powell says he wants to wait and see what policies the incoming Trump administration will implement before the central bank forecasts what it means for the economy.
“There’s nothing to model right now,” Powell said at his Nov. 7 press conference. “We don’t guess, we don’t speculate and we don’t assume.”
That’s not how the Fed responded to President-elect Donald Trump’s win in 2016, transcripts from meetings at the time show. A month before the inauguration, the Fed’s staff began forecasting a fiscal boost to growth that would be partly offset by higher interest rates, based on an assumption that promised tax cuts would get passed. And several policymakers, including Powell, also incorporated fiscal policy changes into their forecasts.
“It seems likely that more accommodative fiscal policy will arrive during 2017,” Powell, then a governor, wrote in comments submitted with his forecasts at the December 2016 meeting of the Federal Open Market Committee. “I have therefore followed the staff baseline in assuming a personal income tax cut of 1% of GDP, as a placeholder.”
He went on to say he had changed his rate projections to incorporate three, instead of two, quarter-point interest-rate hikes in 2017.
A spokesperson at the Fed declined to comment.
Powell’s extra caution compared to 2016 is striking, given that Trump’s policies are expected to reignite price pressures, and Fed officials are still working to finish off their toughest bout with inflation in four decades. How much further they can lower interest rates will still depend, at some point, on how they see the cross-currents of tax, tariff and immigration policies affecting the economy.
“The job’s not quite done” on inflation while the economy could get a lift from deregulation and business-friendly tax policies, said Randall Kroszner, a former Fed governor and a professor of economics at the University of Chicago’s Booth School of Business. “They are going to be on a shallower path” with interest rates in the short run “as the economy gets a boost.”
Political Risks
Just how and when to position around fiscal stimulus is fraught with political risks for central bankers who have run afoul of tax-cutting presidents in the past. If they raise borrowing costs too early or too much to offset the effects, they get criticized for leaning against the administration’s policies. Raise rates too little or too late, and inflation may heat up as it did in 2021.
Eight years ago, it proved difficult to accurately predict the impact of Trump’s proposed policies. The Fed ended up cutting rates beginning in July 2019, just 19 months after the passage of Trump’s signature package of tax cuts, in response to a slowdown in manufacturing and an inflation rate that had fallen back to below their 2% target.
To former Fed Governor Laurence Meyer, who had to grapple with the George W. Bush tax cuts in 2001, the Fed’s current response should remain strictly at the staff level.
“They should be running alternative simulations” to get a sense of how the economy would perform if taxes were cut, he said. “They shouldn’t be basing their policy on something where they don’t know what is going to happen.”
Still, others worry the Fed could err if they wait too long to react. Trump once again promised lower taxes, and with control of both the House and Senate, an extension of his first-term tax cuts is looking like a good bet.
“The patterns we have here for unified Republican control has not been a model of restraint,” said Sarah Binder, a senior fellow at the Brookings Institution. “I could see why central bankers might want to duck out of the wind and get a better sense of what’s coming,” Binder added. “But it does risk getting behind the eight ball.”
Several Wall Street banks haven’t waited. Since Trump’s re-election, economists at JPMorgan Chase & Co., Barclays Plc and Toronto-Dominion Bank have reduced the number of rate cuts they anticipate through next year. Investors have also pared back their expectations for rate cuts in 2025.
Whatever the Fed’s response, what’s really required is a regularized process for handling potential action from the White House and Congress, said Ellen Meade, a former senior policy adviser at the Board of Governors who is now a research professor of economics at Duke University.
“Having a systematic process around how and when prospective fiscal initiatives are incorporated into the baseline Tealbook forecast is critical to ensuring consistent treatment of prospective policies proposed by either political party,” she said, referring to the Fed staff’s forecast and strategy document.
2016 Assumptions
In December 2016, some Fed policymakers, including William Dudley, then president of the New York Fed, raised questions about the staff’s decision to pencil in a more expansionary fiscal policy. Dudley is now a Bloomberg opinion columnist.
Stephanie Aaronson, then an assistant director of the Division of Research and Statistics, told the committee that House Republicans had a plan that was similar in magnitude to what staff built into their forecast. Aaronson is a senior associate director at the Fed today.
Kyle Pomerleau, a senior fellow studying tax policy at the American Enterprise Institute, said that while that plan was more vision statement than draft legislation, it was nonetheless “a very reasonable assumption” in late 2016 that Congress would pass individual income tax cuts and boost demand.
This time around, he said, it may not be so reasonable to do the same. “There is less agreement among the Republican caucus on what to do,” said Pomerleau. “The deficit is higher.”
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