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The Federal Reserve under Trump could lead to inflation

In “The Myth of Independence: How Congress Governs the Federal Reserve” — a must-read for all Fed watchers — authors Sarah Binder and Mark Spindel argue that lawmakers perpetuate a never-ending cycle of crisis and reform. They create banking laws in response to a crisis, then criticize Fed policy and ultimately reform the Federal Reserve Act. (The act created central banking in the United States in 1913 after two previous failed attempts.)

It’s a nonvirtuous circle of events, the authors write, perpetuated by politicians who want to offer quick fixes and maintain their power.

Could 2018 be a major year in this cycle of crisis and reform? As long as the Fed delivers on its mandate of consistent economic growth, stable prices and full employment, Congress and the president generally ignore monetary policy. This year we may see a confluence of events that shake their complacency.

One has to wonder how much of the recent economic recovery can be attributed to such a long period of low interest rates and low inflation.

The one-quarter-percent increase by the Federal Reserve in December will likely be followed by several more increases in 2018 and 2019. That’s good news for savers, but higher rates will also influence commercial and residential mortgages, credit cards, consumer loans, adjustable loans, business borrowing and bond prices.

The president will fill two vacant positions on the Fed’s Board of Governors in 2018, plus two more by the end of 2020. Congress just passed expansionary fiscal policy through the tax reform bill. Fed balance sheet reductions that began in October 2017 could dump up to $50 billion of U.S. Treasury bonds and mortgage-backed securities on the bond market every month. Lighter regulations may lead to 3 to 4 percent higher GDP growth, plus higher deficit spending to support new infrastructure construction. All these policies combined might lead to higher inflation.

Since 2008, the Fed has become the only game in town by providing unprecedented — nearly unlimited — monetary stimulus in response to the Great Recession. With the midterm elections this year, and one-party control of the legislative and executive branches, what will Congress do to reign in Fed power?

If history is any guide, the answer is little or nothing — not until the next crisis causes a rewrite of banking laws as the president and lawmakers attempt to wrest more control of regulations and monetary policy from the Fed.

Watch a video discussion with the “Myth of Independence” authors.

Mark Daly is an investment management analyst and partner in the Perpetua Group. Mark@ThePerpetuaGroup.com.

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