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Memo to the Fed: Remember 2008

One thing I learned during more than 40 years as a journalist is that the power to set the terms of the debate sometimes can be decisive in determining the outcome of the debate.

That could be happening now with monetary policy. By loudly demanding that the Federal Reserve lower interest rates – and announcing plans to appoint to the Fed two men who agree – President Trump may be making the issue one of whether the Fed should lower rates, rather than one of what the proper level of rates are.

There is at the moment no hard evidence that the economy is slowing from the rapid growth shown in 2018 – growth that only a few months ago led most observers to think the Fed would continue to raise interest rates in 2019.

This week the Labor Department reported that in the first week of April there were 196,000 new claims for unemployment insurance filed. The last time there were fewer claims filed was nearly half a century ago, in October 1969. Of course, the labor force was less than half as large then as it is now, so on a proportional basis this is a record low in new claims.

The big stimulus for the economy in 2018 was the Trump tax cut passed at the end of 2017, coupled with a (temporary?) rise in government spending. There is no evidence now that the tax cut will have a long term impact – as it would if it caused productivity to rise – but it provided a large dose of Keynesian stimulus.

That stimulus will eventually wear off, but it does not yet seem to have done so.

This year there are perhaps three possible alternative scenarios. By far the least likely is a quick recession. There was talk of that when the stock market swooned in December and jobless claims rose a bit. Those soon reversed, but in March the yield curve inverted for a brief time, restarting the negative commentary. That too has faded, although it could return. If there is a significant slowing in the economy, monetary easing might be appropriate.

The second possibility is a slowing from 2018’s unsustainable pace for job growth, but continuing at a healthy clip. Under such circumstances there would be no cause to lower rates, but perhaps not a strong case for further increases.

It is the third possibility that concerns me now – of continued strong growth coupled with what Alan Greenspan once called “irrational exuberance” in asset prices. Last year the economy added 240,000 jobs a month, the most for any year since 2006. There appears to be little threat from inflation today, just as was the case in 2006. And just as in 2006, the Fed’s lifting of interest rates last year has been greeted as a mistake by many who point to the absence of any goods and services price pressures.

Of course there was a threat in 2006, as we learned all too well a couple of years later when the financial crisis exploded, sending the world into recession. As Fed Chairman Jerome Powell put it in a speech at the Jackson Hole conference last August, “in the run-up to the past two recessions, destabilizing excesses appeared mainly in financial markets rather than in inflation. Thus, risk management suggests looking beyond inflation for signs of excesses.”

If the economy does extend its unsustainable 2018 trajectory this year – if jobs continue to grow around 200,000 a month and unemployment continues to decline – the risk of financial excesses will grow, and a wise Fed would consider whether it was time to raise rates again, and perhaps take other steps to restrain the economy. We now know that such steps would have been wise in 2005.

But if the issue in the public arena is not whether financial excesses are growing, but only whether rates should be reduced amid low price pressures, then the Fed might compromise on a policy of doing nothing. We could all cross our fingers and hope that would work out better than it did after 2005. I, for one, would feel better if I were sure the Fed will not so quickly forget the lesson that Chairman Powell elucidated so recently.

Floyd Norris, a fellow at the Center for Financial Economics, is a former chief financial correspondent for The New York Times.