All presidents face a dilemma regarding the economy. They are judged in large part according to how wages, jobs, and retirement nest eggs perform on their watch. Yet they have little control over that performance. Growth, ultimately, is determined by long-term (and in some cases mysterious) factors: demographic trends, business innovation and technological progress, the education level of the workforce. Under the right circumstances, some measures—tax cuts, government spending—can boost growth, at least for a while. But for the most part, presidents cannot quickly influence the deeper elements that govern growth.
There is, however, one lever that seems temptingly close to their grasp. If the Fed can be persuaded to hold down interest rates, cheap loans can boost home purchases, car purchases, and business’s spending on factories and machines, pumping up demand and juicing the economy. The Fed’s power is especially tantalizing because of the technocratic tidiness of its decisions—a single committee of experts sets the short-term interest rate as it pleases, with no need to run the gantlet of lobbyists, advocates, and congressional committees. In the long run, of course, lower interest rates are not a magic elixir. The extra demand may run ahead of the economy’s ability to supply things, causing scarcity that leads buyers to bid up prices, thus boosting inflation; and inflation, once permitted, can be tamed only by means of painful job losses. But in the short run, a Fed-created sugar high can transform a president’s fortunes.
Now, after years of rock-bottom interest rates following the 2008 crisis, the possibility of hiring bottlenecks and price pressures has reappeared on the horizon. Having recovered painfully and slowly from the crash, the U.S. economy is expected to grow by more than 2 percent this year—not very fast, but faster than the roughly 1.8 percent that the Fed considers to be sustainable without increasing the rate of inflation. The labor market, after all, is tight: Headline unemployment stands at 4.5 percent, considerably below its average of 6.2 percent since the start of 2000. The broader measure of unemployment—including workers who have given up looking for jobs and part-time workers who’d prefer to work full-time—tells a similar story. With workers now relatively scarce, companies must offer more to attract them. Higher wages, when matched by higher productivity, are a good thing. But if wages rise merely because of worker scarcity, companies may have to pass on the costs to consumers, stoking inflation.
Given these facts, the Fed has little choice but to hike the short-term interest rate from its current low level—if inflation is allowed to accelerate too much, workers will pay a terrible price later. Sure enough, the Fed has already started down that path, lifting borrowing costs in December and then again in March; two more hikes are expected before 2017 is over. In a normal political climate, this might feel routine. After all, the Fed is still paying people to borrow, in the sense that its lending rate is negative after accounting for inflation. But today’s political climate is far from normal. If Trump believes even part of his own rhetoric, his reaction to Fed tightening could well become aggressive.