In early May, John C. Williams, president of the San Francisco Federal Reserve Bank, gave a talk in New York with the title, "Preparing for the Next Storm."
It was an apt description of what central bank policy has been all about for the past couple of years. Eventually the Fed will again have to deal with an economic storm whose advent and magnitude are unknowable, particularly given the great uncertainty about what policies President Trump may decide to pursue. All the Fed can do for now is to continue its slow, cautious steps to move its policies back to a neutral position--a process called normalization.
Fed officials, from Chair Janet L. Yellen on down, hope that process, which began in 2014, can be completed before any storm arrives because there are so many flash points around the world that could precipitate one, including the extremely unpredictable man in the White House. Investors have bid up most stock prices partly in expectation that Trump will follow through with promises to cut taxes significantly, reduce federal regulation of business, and spur economic growth with a $1 trillion program of infrastructure investments. He and various federal agencies have begun to trim regulation, but his tax cut plans were described on a single page with few details, and other than an insistence that Congress approve money for the promised wall on the Mexican border--which did not get included in this year's budget--no infrastructure program has been laid out.
In short, there is no sign of the faster economic growth investors appear to be anticipating. Manufacturing jobs continue to be lost as productivity gains reduce the need for factory workers and hundreds of thousands of retailing jobs are being lost as chains such as Macy's and Sears lose sales to Amazon and other online competitors. With unemployment nevertheless below 4.5 percent and the Fed slowly raising its target for overnight rates, the likelihood of a sustained increase in growth seems extremely unlikely. So what happens if investors accept that reality and the incredible stock market rally runs out of gas? Perhaps nothing much, but what if something else happens too, such as a crisis involving North Korea or another critical spot, or perhaps a failure of some European banks?
One of the key things that worries Williams and most other officials is that if some sort of crisis erupts, they have very little room to combat it with the traditional cuts in their overnight interest rate target. Many observers expect the Federal Open Market Committee to raise that target by a quarter percentage point when they meet in June, but if they do, it would still be at a range of 1 percent to 1.25...