Trump nominee for Fed calls for sharp interest rate cut

The Federal Reserve building on Constitution Avenue in Washington, on March 27, 2019. PHOTO: REUTERS

WASHINGTON (WASHPOST) - Dr Judy Shelton, US President Donald Trump's intended nominee to fill an open seat on the Federal Reserve Board, is calling for a large interest rate cut at the Fed's July meeting.

When asked if she would support reducing interest rates by half a percentage point in July, Dr Shelton said she would and indicated she would have voted for that size of a cut in June had she been on the Fed board.

"Yes. I would have voted for a 50-basis point cut at the June meeting," she said in an e-mail on Monday (July 22).

Wall Street traders anticipate a more modest 25-basis-point cut when the Fed meets to set interest rate policy on July 30-31, but Dr Shelton said there is justification for a deeper cut, citing weak economic conditions overseas.

"I do think global conditions and the clear monetary paths being signalled by other central banks are a factor in considering how much our own Federal Reserve might choose to lower on July 31," she said.

Dr Shelton's views echo Mr Trump's repeated calls for the Fed to lower interest rates. Mr Trump argues the United States is at a competitive disadvantage because the Fed has interest rates at just shy of 2.5 per cent, much higher than Europe's zero rate or Japan's negative rate.

"With almost no inflation, our Country is needlessly being forced to pay a MUCH higher interest rate than other countries only because of a very misguided Federal Reserve. In addition, Quantitative Tightening is continuing, making it harder for our Country to compete," Mr Trump tweeted on Monday.

He has attempted to push the Fed in a different direction by engaging in unprecedented public bashing of the central bank and by nominating candidates to the Fed board such as Dr Shelton, a former adviser to Mr Trump's campaign who shares his belief that rates should come down.

Fed leaders, including chair Jerome Powell, have indicated they think global head winds and Mr Trump's trade war have dented the economic outlook enough to warrant an "insurance" cut in interest rates to try to head off any worse damage. But Fed leaders have been careful to point out that the US economy is still solid with strong hiring and consumer spending.

Central banks typically reduce interest rates when there are signs of trouble, not when the economy is in a good place. Several Fed leaders, including Dr Eric Rosengren of the Boston Fed and Ms Esther George of the Kansas City Fed, do not see any need to cut interest rates right now because of the economy's health.

"I think as long as the economy's doing well, if that continues, we don't need accommodation," Dr Rosengren told CNBC last week.

Dr Shelton, a conservative scholar with expertise in international economics, was highly critical of the Fed's move to slash interest rates in the US to near zero in the aftermath of the financial crisis. Some economists accuse her of flip-flopping on her views now that Mr Trump is president, but she says her critics are misreading what she is advocating for.

"Even a 50-basis-point reduction would still keep the Fed funds rate well above zero," Dr Shelton said. "The target range of 1.75 to 2 (per cent) was maintained from June 2018 to September 2018 before two more increases were imposed."

The Fed technically sets two interest rates when it meets - one is the widely watched benchmark rate, which is the rate banks use to lend each other money to ensure they have the required amount of money deposited at the Fed every night. The other rate is known as "interest on excess reserves", which is the interest rate the Fed pays bank when they hold extra cash at the central bank.

Dr Shelton said the Fed should stop paying interest in excess reserves, a practice she argues is "unhealthy" and results in the Fed paying banks "essentially... to do nothing" with the money instead of lending it out. She would like to see this eliminated in the next two years.

But Fed leaders and many economists have defended the practice, saying it is a must faster way to influence the economy and it is utilized by central banks around the world.

Interest on excess reserves "is the critical rate," Mr Powell told Congress earlier this month. "That's how we manage monetary policy. We've been doing that for really 10 years now, and we decided earlier this year that we would remain that system."

Many economists say Dr Shelton's views are outside the mainstream and would cause disruption in markets and likely force the benchmark rate down to zero as well.

"The Fed's view on excess reserves is it's a tool to give them greater control over short-term interest rates," said Dr Seth Carpenter, a former Fed economist who is now at UBS. "If you stop paying interest on excess reserves, short-term interest rates would fall rapidly, probably get close to zero."

Dr Shelton said she wants the Fed to return to the system it used before 2008.

"The Fed can engage in traditional open market operations to arrive at the target rate, that is, by buying and selling government securities, of which it owns US$3.5 trillion (S$4.8 million) in its portfolio," she said.

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