Extreme reaction to Dudley highlights a practical point

As you know, former NY Fed President Bill Dudley has received widespread condemnation for his suggestion that the Fed should act politically, to frustrate Trump’s trade agenda and perhaps even to prevent his re-election.

That Dudley’s idea got no traction, even among liberals, is not surprising.  But the vehemence of the response has been striking.  In some cases, it has seemed like almost religious incantation, even to this fellow believer. Maybe the Kennedy school of government will issue a fatwa or go ex-Cathedra.

But this rhymes with an issue that is actually controversial and relevant to investment strategy.  The case against Dudley’s case against “enabling” Trump involves pretty much the same considerations that would prevent the Fed ever using monetary policy to lean into a bubble.   In fairness, Fed bubble fighting would be much less “explosive” than Fed Trump fighting, but if you would kindly overlook that matter of degree, you may see what I am driving at here.

Dudley’s argument is that the Fed should take the longer view to preserve economic stability and the proper functioning of markets. Accordingly, it should not offset the contractionary trade policy shock by cutting the funds rate.  While accommodation might assist in the maintenance of full employment and tolerable inflation performance in the medium term, it would just encourage and store up larger problems for later on.  To take the longer-term perspective, the Fed would have to gore some political oxen, true. But at the end of the day that would be worth it.  So claims Bill Dudley.

Almost everybody, excepting perhaps the Fed watcher at Cornerstone (“dead right”), agrees that that is not on.  And yet people are quite open-minded that the Fed might — under some conditions that never seem to apply – do pretty much the same thing to stop a financial market bubble.  That is, to arbitrarily punish some special interests and sacrifice the medium-term macro objectives on the premise that it can make a value judgment that others are incapable of making.

Directionally, that is just as off base as trying to stymie Trump, in my view.  Admittedly, it presents a much less extreme case.  Still, I would guess the odds of the Fed fighting a bubble with monetary policy are about the same as the Fed fighting Trump: very low to zero.

I have mentioned this many times before.  But consensus is not so tightly in agreement on this as they are on not going after Trump. So, I figured I would trot out the harder – and more relevant – case, by invoking rhyme.

The dirty little secret of bubble fighting is that the case against it is not just technical, related to the difficulty of using a blunt instrument to go after a fine problem. The case against bubble fighting is also political.  Indeed, many of the people who agitate for using monetary policy to go after a bubble are actually deflecting. They know it would never happen – enough to matter — and would prefer to keep the discussion away from regulatory efforts that might actually work.  See some bankers, American.

But that gets very little airtime, which also reflects a bit of piety.