The Federal Reserve under Chairman Jerome Powell and President Trump have avoided clashing over the president’s tax cuts and spending increases — a historical aberration.
Past presidents have faced difficulties with the Federal Reserve when they pushed through big tax cuts. Nevertheless, Trump has evaded such a stare-down, even though he has stirred controversy by commenting on the Fed’s monetary policy decisions.
There is an inherent tension between the presidency and the Fed: The Fed’s mandate to keep prices steady conflicts with the president’s incentives to cut taxes and boost spending to please voters.
Trump has done both. First, he joined with congressional Republicans to enact a $1.5 trillion tax cut. Then, he negotiated spending increases with leaders of both parties. Altogether, legislation in his first year added $2.7 trillion to the expected deficits over the next decade, according to the nonpartisan Congressional Budget Office.
In the view of the Fed, those deficits represent fiscal stimulus and run the economy hotter. All else equal, they should increase inflation and require the Fed to react by raising interest rates and tightening monetary policy.
That would be a big problem for the Trump tax cuts. The point of a supply-side overhaul is to make it cheaper to invest. Higher interest rates would cut against that goal, making it more expensive for businesses to finance new projects.
Not all else is equal, though. Fed officials have been mulling over the impact of the tax cuts and spending increases for months and haven’t reached a definite conclusion about what they mean for the economy, according to transcripts of their meetings. Too many other issues are going on for them to focus on the tax changes.
More recently, the tax cuts seem to have fallen off the Fed’s radar almost completely. At the most recent meeting that Powell led, in May, there was little talk about the tax overhaul, according to the minutes that were later released.
Instead, Powell and company were more preoccupied with the tariffs that Trump has threatened. Businesses all over the country are worried about tariffs hitting their supply chain or about retribution from U.S. trading partners.
In moving the tax cuts from the center of the monetary policy debate, the Fed has defused the top potential source of conflict with the White House.
Less tension is good. The relationship between Trump and the Fed has been fraught ever since his harsh denunciations of former Chairwoman Janet Yellen while on the campaign trail.
Last month, Powell addressed the possibility of conflict, saying that the Fed can’t take its independence for granted. “We must not forget the lessons of the past, when a lack of central bank independence led to episodes of runaway inflation and subsequent economic contractions,” he said at a conference in Stockholm.
One such episode followed the Kennedy tax cuts. President Lyndon Johnson, having ushered through the major tax cuts in 1964, became enraged when Fed Chairman William McChesney Martin moved to raise interest rates in response. He demanded that Martin fly down to his Texas ranch and reportedly physically threatened him.
In 1982, having pushed through a first round of tax cuts, President Ronald Reagan clashed with Fed Chairman Paul Volcker over his management of the money supply, at one point declining to say he should stay in office.
More generally, Reagan vacillated on Volcker’s monetary decisions, initially backing his effort to end years of out-of-control inflation via higher interest rates and later second-guessing his month-to-month decisions.
Other supply-siders, though, sought to pressure Volcker not to raise rates to protect the tax cuts. Jack Kemp, the New York Republican congressman who helped write the tax cut, went so far as to call on Volcker to resign.
Even Alan Greenspan and President George W. Bush experienced friction over Bush’s tax cut, despite the established norm that the White House shouldn’t comment on the Fed’s monetary policy decisions.
In 2003, Greenspan warned the administration that, by allowing large deficits, “you will be significantly undercutting the benefits that would be achieved from the tax cuts.”
Later, he said that he had counseled Bush to veto spending bills during frequent trips to the White House.
Powell has avoided such traps so far.
He has told Congress and Trump that they should lower deficits. But he has danced around the topic of tax cuts.
At Powell’s most recent testimony in the Senate, Tennessee Republican Bob Corker asked him directly if the tax overhaul would lead him to tighten monetary policy.
“I wouldn’t single it out,” Powell said of the effect of the tax cuts.
One Fed member, Lael Brainard, has said that the tax cuts would be a factor militating toward tighter money. In a March speech, she described the cuts as one of the “tailwinds” boosting the economy. Previously, she had argued for slower rate hikes on the grounds that the economy faced “headwinds” from weak growth overseas.
But Powell has avoided steering the Fed in that direction or even acknowledging that the tax cuts could be a determinative factor in his thinking.
In a House hearing, Rep. Brad Sherman, D-Calif., pressed him on the point, asking if the “profligate” tax-and-spending policies under Trump would lead Powell to raise rates.
“I would just say … our own job is to focus not on fiscal policy, but on monetary policy, and so that’s our frame of reference,” Powell responded.
“Thank you for evading my question,” Sherman quipped.
