MNI INTERVIEW: Fed To Stay Careful Amid Policy Turmoil-Johnson
MNI (WASHINGTON) - Federal Reserve officials will be cautious about making any further cuts to interest rates given high levels of uncertainty about the effects of the new administration’s economic policies as well as disagreement over the neutral rate, Nobel Laureate Simon Johnson told MNI.
“They have to see what happens to inflation and how the economy responds to all these noises and the disruptions,” Johnson, an economist at MIT, said in the latest episode of MNI’s FedSpeak Podcast.
“Interest rates have gone down a lot. Why would you expect interest rates to go back down to the unusually low levels of the 2010s? I don’t know what R-star is and nobody knows what R-star is. So I think the Fed’s got to be pretty careful at this stage.” (See MNI INTERVIEW: Fed In Holding Pattern As Inflation To Stay High-Ex-Staff)
Part of the difficulty is gauging how extensively the administration’s proposals on tariffs and immigration will actually be carried out – Johnson believes the policies must be taken seriously but often have more bark than bite.
“A lot of the tariff stuff is meaningful but it’s a negotiating position. He’ll settle for a lot less than you might think,” he said.
BAD FOR BUSINESS
If tariffs do become a persistent part of the landscape, they will likely be a drag on growth, said Johnson, also a former chief economist of the International Monetary Fund.
“The tariff policy that Mr. Trump says he likes and says he wants to impose is going to be really bad for American business and really bad for American jobs,” he said.
That in turn would worsen an already troublesome budget outlook, which Johnson does not believe will be helped by the efforts of Elon Musk’s DOGE program.
“It’s not going to dent projections of federal government outlays. Interestingly, the congressional conversation is not selling us on the idea that DOGE is going to bend the curve on healthcare or social security or anything else that really drives the federal budget. So, smoke and mirrors,” he said.
FED INDEPENDENCE
Despite the prospect of a prolonged Fed pause, Johnson believes the Trump administration will leave the conduct of monetary policy alone despite previous threats to lean on the central bank for lower interest rates.
He pointed to a sweeping executive order Tuesday that asserts vast executive power over regulatory agencies but specifically exempts the FOMC’s monetary policy function.
“The reason they did that is that, as James Carville famously remarked, you do not want to get on the wrong side of the bond market,” said Johnson, referring to the former aide to President Bill Clinton.
“There’s a dance between the White House and the Fed that has a permissible space. It’s very interesting that this White House that has little or no guardrails on many dimensions, has gone out of its way” to leave interest rate policy out of bounds, he said.
Johnson noted that while Fed Chair Jerome Powell will likely be replaced by a “Republican loyalist” when his term ends in 2026, that doesn’t mean the chair’s successor will be able to behave any more dovishly.
“You can try to run an easy monetary policy at various moments but if the market believes that you’re going to fall behind the curve then it doesn’t matter what you do with short rates, long rates are going to go up,” he said.