Thread by @karlbykarlsmith

Good thread from @TheStalwart.

Dudley's op-ed is misguided, and deeply so I feel, on multiple levels.

4 points:

1) It crosses the line on independence in a way so flagrant that its impossible to imagine that Central Banking as we know it would remain. If the Fed openly 1/12

undermined the foreign policy objectives of a duly elected Administration, there is simply no defensible objection to that Administration taking all legal measures to replace the Board of Governors with people supportive of its goals.

2) Allowing the US economy to fall into 2/12

recession on the assumption that the Central Banks both understands and can influence the unstated reaction function of the Adminstration is hubris on a level that can hardly be described. It is easy to imagine that the President already has his mind made up and so 3/12

refusing to play along accomplishes nothing but dragging down the economy further, causing additional unnecessary suffering and directly violating the Fed's congressional mandate

3) While in practice managing a trade war is difficult there is nothing in economic theory 4/12

to suggest that the Fed cannot (nearly) achieve its mandate.

The trade war causes both a demand and supply side shock. The demand side shock can in theory be offset completely. Perhaps, one believes that in practice, this close to the ZLB it cannot be.
5/12

However, as it stands the Fed is above the ZLB, is constraining Aggregate Demand, and believes it is doing so. Otherwise, there would be no need to cite upside risks to inflation when choosing to raise rates.

There is also a supply shock. This cannot be offset in 6/12

real terms. That is the productivity of the US economy will decline and the Fed cannot stop it. The shock can, however, be offset in nominal terms so that overall nominal income does not decline.

If the Fed does nominally offset the supply shock then employment will be 7/12

sustained, but real wages will fall as the cost of goods and services rises. This causes a potential disruption to the stable price mandate.

However, first it is temporary. Once the shock passes through there is theoretically no further effect on prices.

Moreover, the Fed 8/12

has failed to *reach* its inflation target of 2% for the last years.

In the most dry telling, the trade war actually assists the Fed by inducing inflation that it has found it difficult to produce.

Of course, the real world is more complex than that 9/12

However, what can be the possible justification for refusing to respond to the trade war in a way that, on paper, pushes the US economy towards both its goals of maximum employment and stable prices.

4) Dudley ends with a suggestion so outrageous that 10/12

even having printed it undermines the Fed. The idea that the Fed would intentionally throw the election so as to get rid of a President it disapproved of not only violates the spirit, if not the legal letter, of the Constitution, but it also feeds every rabid conspiracy 11/12

that the President's supporters might have.

I really can't believe that Dudley would make such an irresponsible suggestion and Chairman Powell has no choice but to disavow it publicly and forcefully. 12/12