For the Federal Reserve, the world is almost always an uncertain place. Economic forecasts involve so many variables beyond the central bank's control that they often turn out to be well off the mark. Even the huge financial crisis that ultimately involved almost every corner of the globe struck with little warning, as Fed officials remember all too well. But this year's degree of uncertainly is unique: No American president has ever behaved like
Essentially every aspect of government policy is up in the air as a result of Trump's capricious, often ill-informed pronouncements. Yes, Trump plans to propose large tax cuts, but what kind and who will benefit? Yes, some large spending increases might be put on the table, but there has been no concrete sign of the $1 trillion infrastructure promise he once made. He wants to spend much more on the military, while small-government advocates such as his budget director or Republican members of Congress push for significant spending cuts as well. Will Trump provoke trade wars with China, Mexico, Canada, or perhaps even the European Union? He has threatened to do so. How far will he and his cabinet and sub-cabinet appointees go to roll back regulation of business and financial market activities and environmental protections? And might his sweeping effort to restrict immigration and deport hundreds of thousands of people in this country illegally disrupt economic activity on a broad scale?
Obviously no one knows the answers, certainly not Fed Chair Janet L. Yellen and her policymaking colleagues. As New York Federal Reserve Bank President William Dudley quipped recently, "On fiscal policy stimulus, it's really hard tofactor into your forecast at this point because we don't know what it is, how big it is, or when it will happen. Other than that, we have it completely nailed down." Fortunately, however, Fed officials are extremely well-positioned to deal with whatever Trump and the Republican-controlled House and Senate ultimately agree to put in place.
First of all, the U.S. economy is in very good shape, far better shape than the "disaster" claimed by the new president. It has grown relatively slowly ever since the crisis, but by the end of last year, total economic output was about 13 percent greater than it was in 2008 and the unemployment rate is back below 5 percent. The labor force participation rate is still down from its pre-crisis level, but nearly six million more workers have jobs than did then. As Yellen said in her semi-annual monetary policy report to Congress in mid-February, the economy is close to the "maximum employment" goal set by Congress--that is, the lowest level consistent over time with stable inflation. At the same time, consumer price inflation has moved up close to the 2 percent target the Fed has set as meeting the "stable prices" portion of the congressional mandate.
The current debate among Fed policymakers, therefore, is not about what to do tofix some serious problems in the economy, but rather how to maintain what has been achieved. A majority of the policy-setting Federal Open Market Committee has agreed that the best course is a very gradual increase in the target for overnight interest rates. That target had been held close to zerofor seven years before it was raised by a quarter-percentage point in December 2015. It was boosted by another quarter point last December to a range of 0.50 to 0.75 percent and...