Economic Letter

David Bond is a retired bank economist who resides in Kelowna. This column appears Tuesdays.

Of all of the patently absurd statements made by Donald Trump since his inauguration in 2017, his calling the current chairman of the U.S. Federal Reserve, Jerome Powell, an “enemy of the people” ranks as perhaps the most ridiculous.

This unwarranted epithet apparently was elicited by Powell not immediately lowering interest rates sufficiently to satisfy Trump when he made the totally inappropriate suggestion that the Fed do so.

There two important points to understand about this totally inappropriate and dangerous behaviour on the part of the president. First, because of their critical role in the economy, central banks — such as the Federal Reserve — are supposed to be free of political pressure. Obviously, Trump neither understands nor accepts this concept.

Secondly, Trump himself nominated Powell to the post. When announcing the appointment Trump said, “He’s strong, he’s committed, he’s smart. I am confident that with Jay (his nickname) as a wise steward of the Federal Reserve, it will have the leadership it needs in the years to come.”

Given this high praise, what happened to make the president denigrate Powell? Other than not doing what Trump wanted, there appears to be no justification for this action. In fact, Powell was doing exactly what a central bank chairman should do. As he himself said, “I will continue to work with my colleagues to ensure that the Federal Reserve remains vigilant and prepared to respond to changes in markets and evolving risks.”

Why independence of a central bank is the essential bedrock and foundation of any country’s economy should be obvious after a few moments thought. Foremost is its obligation to protect the value of the unit of account, which in Canada is the loonie. In Great Britain it is the pound sterling, in Japan the yen and in much of Europe the euro.

If a central bank were made subject to a desperate government’s decree to increase the supply of money rather than raise taxes, this could lead to an uncontrolled decline in the currency’s value — especially if the quantity of goods and services available did not increase. Excessive increases in the money supply in Germany in the 1930s or in Israel in the 1980s or in Venezuela in recent years all led to runaway inflation and extreme hardship for businesses and families.

Similarly, the central bank’s ability to determine the overall structure of interest rates on government debt, (it does this by buying and selling government debt securities in the market) is a major tool of monetary policy. If it buys securities that tends to raise their price and therefore lowers the effective rate of interest paid (the interest obligation becomes a lower percentage of the purchase price).

Similarly, selling some of its government securities will lower the price, thereby raising the effective rate earned. Higher interest rates cause investment in housing or new plant and equipment to decline.

Thus by raising or lowering interest rates, it stimulates or dampens economic activity. Because the impact of a change of interest rate takes time to be felt, such actions by the central bank need to be carefully tailored in response to the health of the national economy.

And finally, usually a central bank runs the government’s foreign exchange account. Trade and investment flows both into and out of a country put pressure on the rate of exchange. If our loonie rises in value compared to, say, the U.S. dollar, then buying things in the U.S. becomes cheaper and for Americans, Canadian products become more expensive. That, in turn, impacts on the Canadian economy.

So the central bank has to consider a multitude of factors in deciding how fast the supply of money should grow, at what interest rate and what rate of exchange. This is particularly true for a nation such as Canada where exports make up a significant part of gross domestic product (GDP). A political leader’s fate is not one of the considerations that should be weighed in the balance.

Without independence from political pressure, confidence in a nation’s currency and support for a central bank’s actions quickly crumble. It is Trump, not Powell, who is an enemy of the people.