Making Monetary Policy Great Again

The Great Recession exposed the weaknesses of orthodox central banking. Time for a regime change.

By Ryan Avent

Tagged Donald TrumpEconomicsmonetary policy

This essay was published with the support of the Washington Center for Equitable Growth.

When Franklin Delano Roosevelt was elected President in 1932, America had been in depression for three full years. Roosevelt was a man with a mandate to fix the economy by any means necessary. Barack Obama was elected in the midst of the worst economic crisis since the Depression, yet his campaigns, against both Hillary Clinton and John McCain, were defined by other issues. Obama’s pitch to voters was not chiefly a promise to save and remake the economy.

His presidency was nonetheless defined by the long, slow, and uncertain process of recovery. It is surprisingly easy now, with an unemployment rate under 5 percent and the economy typically adding jobs at a clip of more than 200,000 a month, to forget how tenuous the Obama expansion felt, and for how long. But the scars are still there. The share of Americans participating in the labor force remains far below the pre-crisis level and, despite all the hiring, pay for workers continues to grow at a disappointing pace. And then there is the new President, whose victory was at least in part shaped by economic hardship and frustration with elites.

Obama’s response to the economic crisis he inherited often inspires criticism: of the timidity of his stimulus plan, of his failure to provide broad support to struggling homeowners, and of his premature pivot to deficit cutting. But while Roosevelt’s New Deal programs left an indelible mark on the American economy and society, it was his decisive monetary action that saved America from continuing depression. On just his third day in office, Roosevelt declared a bank holiday and effectively suspended the country’s participation in the international gold standard, freeing his Administration to pursue a policy of reflation. The economic response was immediate. Industrial production soared in the months following this action, beginning a four-year stretch of rapid growth (though America would not make up all of the ground lost in the Depression until the early 1940s).

Obama would not pursue any comparably radical policy. After initial fiscal stimulus, and efforts to shore up the banking system, his Administration left the hard work of rehabilitating the economy to the Federal Reserve, while the federal government turned to deficit reduction. That decision was understandable; an obstinate Republican Congress was not going to deliver more fiscal stimulus. Perhaps more important, the decades prior to the crisis taught political leaders that economic management was the Fed’s job, one it could handle ably.

Experience since the financial crisis strongly suggests that assumption was mistaken. It should not have taken six years to return the unemployment rate to the pre-crisis level, nor should so much of the reduction in unemployment have come in the form of frustrated workers leaving the labor force. American incomes should not have been allowed to fall below the pre-crisis trend, and at least some of that shortfall ought to have been made up. Most critically, now, nearly ten years after the start of the Great Recession, the economy should be far better prepared to deal with the next crisis, not trapped with interest rates stuck near zero and the labor market still signaling that more people could be put to work for longer hours at higher rates of pay.

As the Great Recession recedes into the past, the sense that urgent change in the making of economic policy is needed also fades. But new storms will brew in the years to come. Change, when it comes in America, will now be handled by the Trump Administration.

After the recession, a question arose: Had the Fed failed because it did not try hard enough, or did it fail because success was impossible?

Donald Trump did run on a platform to remake the American economy, though his failure to earn more votes than his opponent makes it difficult for him to credibly claim a mandate for change. All eyes will focus on Trump’s trade policy, his border wall, his efforts to browbeat American companies into creating manufacturing jobs. He has so far given little indication how he might approach monetary policy.

Yet the support that he and Bernie Sanders received in 2016 suggests that voters are ready for politicians to take responsibility for macroeconomic policy. Voters have a point.

Not long ago, central bankers were seen as near-omnipotent helmsmen at the tillers of the world’s great economies. In 1997 Paul Krugman wrote, in a piece criticizing “Vulgar Keynesians”:

[I]f you want a simple model for predicting the unemployment rate in the United States over the next few years, here it is: It will be what Greenspan wants it to be, plus or minus a random error reflecting the fact that he is not quite God.

The Great Recession shattered that faith. Not only was the Fed unable to prevent the downturn that began in the fourth quarter of 2007 from turning into the direst economic maelstrom in almost a century, but in the long years after, it repeatedly overestimated the health of the economy. As these woes unfolded, old arguments about monetary policy erupted anew. At the heart of the disagreements stood a simple question: Had the Fed failed because it did not try hard enough, or did it fail because success was impossible?

It is a question as old as macroeconomics. In 1936 John Maynard Keynes published his General Theory of Employment, Interest and Money. In it, Keynes set out a powerful case for why the supply side of the economy—how much stuff it is capable of producing—is not the only factor determining the size and health of an economy. Rather, demand—what people are willing to spend—is hugely consequential in determining how much is produced and how many people are left without work.

Keynes’s reasoning provided the lens through which we analyze recessions today. One person’s spending is another’s income. Should some gust of bad news shake confidence and cause spending to fall across the economy, a recession can result. Such shocks, even small ones, can feed on themselves: As people grow nervous and cut back on spending, businesses curtail investment plans and lay off workers, further reducing spending. Slumps are not simply instances of market failure. They are also bouts of collective madness. Pessimism breeds excessive caution, which leads to a recession that justifies the pessimism. Correspondingly, fixing recessions is not simply about mechanically raising the level of spending in an economy, but also about coordinating the expectations of the public back to a healthy equilibrium. It’s about convincing everyone that things are going to be okay.

This understanding of recessions implies that there is a role for government action to keep economies from spiraling into downturns. But how? Among Keynes’s contemporaries some, like Irving Fisher, thought the solution was to satisfy a worried public’s hunger for liquid cash by printing more. Others reckoned the key was reducing interest rates to discourage saving and boost investment. Keynes went further. In times of deep depression, he posited, it could be that no amount of monetary meddling can get the economy moving again. Instead, governments need to run budget deficits and spend money to “prime the pump.” John Hicks built on this in setting out the idea of a liquidity trap: a rut in which interest rates in a slumping economy fall to zero. A zero rate represents a hard bound, because at negative interest rates people will choose to hold cash, which yields zero, rather than leave their money in bank accounts to slowly evaporate. There an economy can remain stuck, lest the government come to the rescue with deficit-financed spending.

As this debate rolled on through the 1930s, the public took sides. Roosevelt’s gold policy may have turned the tide, but New Dealism was a broad set of government interventions, and it was not until the massive government spending of World War II that advanced economies were unquestionably running at full tilt. Keynesian ideas were triumphant, and elected governments saw maintaining full employment as a critical responsibility. Central banks played only a bit part; in 1960 it was Eisenhower’s budget cutting that annoyed Nixon, who needed a strong economy to support his candidacy for the presidency, not the decisions of the Federal Reserve.

But old macroeconomic arguments never subsided, and by the 1960s the Keynesian consensus was under attack. The unravelling began with the work of Milton Friedman and Anna Schwartz. In their Monetary History of the United States, the two compared changes in money supply to episodes of inflation and deflation, and to corresponding hiccups in the real economy. During the Great Depression years, they pointed to an extraordinary decline in the money supply, and a corresponding great deflation, as the cause of the calamity. The crisis could have been averted had the Federal Reserve simply printed more money.

Other economists built on these ideas, in incorporating forward-looking expectations into their understanding of how people respond to policy. Rational-expectations economists pushed economics back toward a pre-Depression state; they argued it was no use using government spending to prime the pump, for instance, since people would understand that borrowing would need to be paid off later and would save any additional income to pay the tax bill to come.

But the true watershed in the debate arrived with the wave of great inflation of the 1970s. Slumps were not the only way demand could misfire, it turned out. Willingness to spend could also run far ahead of the economy’s ability to produce, such that more spending translated into higher prices rather than more output. Critics of Keynesianism argued that this was the inevitable outcome of activist macroeconomic policy, and in particular of government efforts to maintain full employment.

The view of monetary policy that began to cohere in the 1980s and remains the bedrock of central-bank policy is a simple one. It says that demand is reflected in nominal variables, like inflation. When there is too little spending to maintain full employment, inflation will decline and perhaps go negative, and when spending growth outpaces growth in economic capacity, prices will rise faster. For central banks to do their jobs effectively, it is sufficient to target inflation. If the target is public and credible, markets should help the central bank do its work; when inflation slips, markets should anticipate monetary expansion, and should therefore behave in a more confident manner, thus averting a downturn.

Perhaps most important, this view holds that if the central bank is targeting inflation, fiscal policy is neither necessary nor useful. If a central bank is making policy in order to keep inflation on track, then a stimulus package passed by the legislature threatens to raise inflation above the central bank’s comfort level. It will therefore tighten monetary policy, offsetting the effect of government stimulus.

The new monetarism faced a test in the disinflations of the 1980s. Many Keynesians argued that unemployment would need to rise to Depression-era levels in order to rein in inflation, which, in their view, had deep structural roots. In the event, unemployment in America rose above 10 percent as Paul Volcker, then the Fed’s chairman, raised interest rates to eye-watering heights—19 percent. But inflation fell—from nearly 15 percent in 1980 to less than 3 percent in 1983—and the experiment was judged a success. Indeed, the lesson that aggressive monetary policy could bring even the fiercest inflation to heel was etched deep into the memories and belief systems of the central banking profession.

As with the Depression, monetary policy was decisive, but the political change associated with the change in the economy reached farther. It was the dawn of an era in which the government sought to manage with a light touch. And at the helm of the macroeconomic ship stood the all-powerful central banker, the pure technocrat, to whom even the President deferred, deftly steering the economy through trouble spots with a nudge to interest rates here and there. Central bankers could make or break presidencies; Alan Greenspan may well have cost George H.W. Bush the 1992 election by not cutting interest rates faster for fear of inflation, leaving Bush a lackluster recovery to run on. And yet the sanctity of Fed independence was so great that no President would dare politicize the institution or question its autonomy, even as Greenspan and subsequent chairmen felt comfortable weighing in on how the rest of the government did its budgeting.

And then, events conspired to pull the curtain away.

The limits to central banker infallibility began to become clear in the 1990s. In America, Greenspan’s Fed tried and failed to pop the stock price boom at the end of the decade, only to struggle to rekindle rapid growth after the recession of 2001 came to an end. Yet the most glaring failure had occurred earlier, in Japan. Japan’s long, extraordinary postwar economic boom crashed to a halt in 1990, as the air came out of a massive asset-price bubble. The Japanese government and the Bank of Japan struggled to manage the subsequent slump. By the late 1990s, the Bank of Japan had finally cut interest rates to zero to try to revive growth. It subsequently turned to a policy called “quantitative easing” (QE); the central bank created new money that it injected into the banking system through purchases of government debt. The banks, it was thought, would use the money to buy assets, stocks, and bonds. That, in turn, would reduce long-term interest rates and buoy asset prices, making it more attractive for firms to invest.

Not until the early 2000s did Japan begin shaking off the rust; economists attributed a “lost decade” to Japan. Scarcely had the Japanese economy found its footing when the global financial crisis drove it back into slump conditions. In Japan, the world had to confront abject central-bank failure. The arguments that would split economists after 2008 began then, in trying to work out what Japan had done wrong.

In 2002, Ben Bernanke, then a respected monetary economist and new member of the Fed Board of Governors, spoke at an event marking Friedman’s 90th birthday. Bernanke closed by saying: “Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.” And indeed, central banks did learn from history. With notably rare exceptions, they did not allow big banks to fail, as governments had with alarming frequency in the 1930s. They also reacted aggressively in the face of deflation; even the European Central Bank, known for its hawkishness, began printing money and buying bonds when euro-area inflation dipped into negative territory. As a result, the Great Recession was far more mild in most economies than the Depression had been (but for a few cases, like Greece).

It was a watershed event all the same. Nearly a decade after the recession began, much of the rich world is still failing to employ all willing workers. For wage growth, too, it has been a lost decade. What’s more, most central banks continue to operate with interest rates at or near zero. Whatever else unfolds in the near future, the days when central bankers could deftly navigate an economy through business cycles with well-placed quarter-point interest rate tweaks are gone, perhaps for good.

What went wrong? To an extraordinary extent, the intellectual debate over how policy failed echoes the arguments that unfolded in the Depression and its aftermath. Now, as then, there are voices arguing that, if anything, too much effort has been expended trying to raise demand. The trouble with such views is that the data do not cooperate. Warnings of a looming surge in inflation, or in interest rates, continually fail to match reality. The day of reckoning could be ahead, but the longer conditions of low inflation, low growth in wages, and low interest rates prevail, the clearer it is that—whatever else might be wrong with the economy—demand remains too weak, and the economy continues to operate below its potential.

A second group, echoing the arguments of Friedman and Schwartz, contends that the Fed was simply too cautious in attempting to revive the American economy. Similar views had been expressed in the 1990s and 2000s, as Japan struggled to escape its slump. Then, economists like Bernanke and Krugman argued that the Bank of Japan, paralyzed by its own conservatism, had failed to take straightforward steps to raise demand—steps like setting a high target for inflation, buying assets in bulk and depreciating the yen. There is no limit to how much money a central bank can create. If it buys enough stuff with the money, inflation will inevitably follow. Demonstrate enough commitment to raise inflation, and the public will begin to believe and behave accordingly by borrowing and spending. In the years after the financial crisis, Bernanke became the target of such criticisms rather than the source. Christina Romer, chair of Barack Obama’s Council of Economic Advisors, argued that monetary policy needed to deliver “regime change”: a shock-and-awe jolt to policy that re-coordinated public expectations in a positive way. Scott Sumner, a little-known figure in economics before the crisis, gained notoriety through his blog, where he argued that the Fed should abandon its obsession with inflation in favor of a target for the level of national income, and that the Fed should set bold forecasts and do whatever it took to hit them. Convincing the public that income growth is going to get back on track in the future is a good way to stop pessimism in its tracks.

Then there were the resurgent Old Keynesians, who saw the downturn as beyond the ability of the Fed to fix. Many of the arguments made by this group were also applied first to the Japanese slump. When asset prices tumbled, companies and banks (and some households) suddenly found themselves with huge debts they could no longer hope to pay, even through liquidating their assets. These debtors stumbled their way through the long downturn trying desperately to stay afloat. Nothing the Bank of Japan or anyone else could have done would have induced them to take out new loans, or make big new investments. On the contrary, their efforts to pay down their debts added to the excess of savings over borrowing that kept Japan trapped.

In the aftermath of the Great Recession, many people reckoned that monetary policy could not work effectively while many households were hugely underwater on their home mortgages. (Indeed, research by Atif Mian and Amir Sufi showed that monetary expansion seemed to be less powerful in places with more negative equity.) Others, like Brad Delong, Lawrence Summers, and Krugman argued that whether or not it was possible for monetary policy to do the job on its own, there was little reason not to use expansionary fiscal policy in an aggressive way: not with the abundant underused resources sitting idle and government borrowing costs at historic lows.

Over time, some members of this group began embracing a fourth explanation for the economy’s persistent slump. What troubled economies were facing wasn’t merely the after-effects of the recent crisis, but the onset of a new, chronic condition. Thanks to aging, or technological change, or some other factor, rich economies seemed to need less investment than in the past. With investment demand dropping steadily, saving must also fall, or the economy would become stuck in a long-term slump: in secular stagnation.

Secular stagnation is not a new idea; it was introduced by Alvin Hansen during the Depression, when he argued that a slowdown in technological progress and in population growth implied a drop in investment and a permanent slump—unless governments stepped in to borrow and spend. Economists like Summers came to see Japan-like conditions as a new manifestation of secular stagnation: a world in which the economy simply had more money sloshing around than it knew what to do with. He suggested other factors that might also contribute to the condition, including rising inequality. The concentration of income in the hands of richer households, which tend to save at much higher rates than those with lower incomes, could place a consistent drag on demand, barring some mechanism for transferring purchasing power from rich to poor.

Concentration of income in richer households, which tend to save at much higher rates than others, can place a consistent drag on demand.

Fiscal expansion or redistribution would be one way to achieve that. Another would be the development of mass lending from rich to poor—through investment in mortgage-backed securities, for example. Central banks are not powerless to raise demand amid secular-stagnation conditions, Summers argued. If they kept interest rates low enough for long enough then asset prices would eventually begin rising, and higher asset prices might entice new borrowing. Central banks could solve the problem, in other words, by nurturing the growth of a debt-fueled asset-price bubble. Hardly ideal.

History being what it is, we cannot know exactly what went wrong or would have led to a different outcome. At the same time, the debate over precisely which policies, in isolation, could have worked, is beyond the point. Few of those who felt that more fiscal stimulus would be helpful were opposed to efforts to improve the efficacy of monetary policy: through an increase or a change to the inflation target, for instance, or, more radically, the introduction of mechanisms that would allow the Fed to directly finance infrastructure spending or individual payments to households (so-called “helicopter money”). Fiscalists are numerous among the ranks of those who criticized the Fed for easing too tentatively, ending QE programs prematurely, and raising rates too eagerly. Similarly, few of those who argued that the Fed could accomplish everything it needed to simply by being more aggressive objected to the idea that governments might take advantage of economic slack and low interest rates to borrow money and spend it on public goods.

What the debate over what to do obscured was the complete lack of appetite for radicalism of any sort. Since the failure of Lehman Brothers, the Fed’s preferred measure of inflation has been below the Fed’s inflation target of 2 percent roughly 80 percent of the time. During that time the Fed allowed multiple QE programs to end and began raising rates. The Fed very easily could have done more to support the economy. It could have done much more QE. It could have announced an inflation target of greater than 2 percent, or it could have made clear that it would deliberately allow inflation to rise above the target for a time in order to make up lost ground. It could have made clear that it was uncertain how close the economy was to full employment and that it would therefore wait for sustained growth in wages of 4 percent or more to begin tightening policy. It could simply have waited longer before moving to raise interest rates.

The Fed did not do these things. It was comfortable enough with the pace of recovery not to risk bolder action to try to accelerate the pace of growth and the reduction in unemployment. That, in turn, suggests that the Fed might also have enforced a ceiling on the rate of recovery had Obama and Congress managed to deliver much more fiscal stimulus. The Fed’s communications make clear that throughout the recovery, it has been guided by the desire to see inflation converge back toward the 2 percent target. So long as it has felt confident that convergence was underway, it has been happy to withdraw stimulus—even when actual, measured inflation remained below the target. The projections released by the Fed after meetings, which provide FOMC members’ forecasts for economic activity given “appropriate monetary policy,” invariably show inflation rising slowly back to 2 percent—almost never popping above, even by a few tenths of a percentage point. Whatever else it might have worried about, policy was always guided by the desire to land inflation squarely on 2 percent, eventually, with as little overshoot as possible.

Some blame the age of members of the Federal Open Market Committee (FOMC) for this behavior; the formative experience for older monetary economists was the great inflation of the 1970s and the effort in the early 1980s to bring inflation down. Others reckon it is the background of the group—largely white, male, and high-income—which makes the Fed less sensitive to deviations in unemployment, as opposed to inflation. Those may be factors, but in practice the central bank is structured to prioritize inflation over other concerns. From the 1970s to the 1990s, many governments moved to increase the operational independence of central banks, largely because economists saw independence as necessary to rein in inflation. Central banks subject to political influence might face pressure to boost growth prior to elections, leading, over time, to steady growth in inflation expectations. That this was the logic of independence necessarily biases the institution toward inflation fighting. Central bankers are chosen for their commitment to price stability; “doves don’t go to central banker heaven,” as the saying goes. Just as postwar Keynesianism reflected the priorities of the politicians of the 1930s; monetary policy today reflects the imperatives of the 1970s.

Yet a crucial factor is that central banks are not, and cannot be, truly independent. They are part of the government, and their status is subject to legislative change. Bold moves and dramatic departures from past practice are not just economically risky but likely to attract unwanted political oversight. Congress will never haul FOMC members in for a dressing-down for keeping inflation at 1 percent for years at a time. Announcing a change in policy with the intention of raising inflation above target is another matter. It would not have been lost on the Fed that Congressional criticism during the Great Recession focused overwhelmingly on its efforts to support the financial system and its asset purchases, rather than on its failure to quickly bring down unemployment.

Taking a step back, central bankers see themselves as technocrats, there to tend the monetary machinery. They can change the oil and top up the tanks, but are not constitutionally disposed to swapping out the engine. Historically, when monetary “regime change” has occurred—when the public has been jolted out of a bad equilibrium into a good one—it is as a result of a political shift. It was Roosevelt that delivered regime change—by suspending gold convertibility—not the Federal Reserve. It was Richard Nixon who ended America’s role in the international gold standard set up after the second world war. In Britain, it was the government of Margaret Thatcher that engineered a disinflationary recession, and a political commitment to Paul Volcker by Jimmy Carter and Ronald Reagan that facilitated the end of high inflation in America. In Japan, where nominal GDP is at last rising in sustained fashion, it was the election of Shinzo Abe, who essentially ran on a platform of monetary regime change (and nationalism), that made the difference.

Monetary policy is powerful. But independent central banks lack the institutional capacity to force a regime change. Historically, it has taken politicians with popular mandates to do that. Whatever one’s theory of Fed failure in the Great Recession—monetary timidity, monetary impotence, or secular stagnation—the solution necessarily entails decisive political action.

Decisive political action is not a characteristic associated with modern American democracy. For that reason, many proposals to reform macroeconomic policy recommend expanding the powers of the technocrats at the Fed: giving it control over some fiscal policy measures. Yet more power for the technocracy is not what is needed; rather it is more accountability over policy.

Change ought to include two components: a shift in the priority of policy and an adjustment to the mechanisms through which that goal is achieved. There are several sensible candidates for the former; perhaps the most attractive would be a switch to a policy of targeting growth in current-dollar national income (that is, not adjusted for inflation). That would re-center policy to better recognise the role of incomes in maintaining adequate demand, and it would free policymakers to worry less about short periods of modestly high inflation when there is slack in the labor market. The Fed should be accountable for its role in meeting this goal; failure to achieve it should result in Congressional inquiries and perhaps in dismissals.

Where mechanisms are concerned, there are opportunities aplenty. The government could build up a pipeline of shovel-ready infrastructure projects that could be brought forward when demand threatens to subside. It could expand the range of assets that the Fed can buy to include stocks or property. Yet it should perhaps go further, to enact public-works programs that could expand indefinitely during slumps, reducing unemployment and helping to inject purchasing power into the economy. Or it could begin basic income payments to all workers, which could be adjusted to respond to changes in demand.

Shifting the onus for macroeconomic management back toward elected officials is not without risk. It could mean that inflation is higher on average and more variable than in the recent past. Yet it is wrong to pretend that central bank independence solves the economy’s demand problem; it merely biases monetary policy toward minimizing deviations in inflation rather than deviations in unemployment.

Given gridlock, it is possible that policy could go wrong, perhaps significantly so. But policy has already gone badly wrong. What’s more, political science research suggests that voters now hold the President accountable for economic performance. When elected officials are prevented by Fed independence from delivering better economic performance, voters may become more open to alternative narratives of economic weakness, such as those espoused by President Trump.

We have little enough idea what a Trump Administration might prioritize where monetary policy is concerned. Trump being Trump, his public statements point in multiple directions. He has said that he is a “low-interest rates person,” but also complained that Janet Yellen is artificially propping up the economy with too-loose monetary policy. Most probably, Trump does not have a firm or coherent macroeconomic worldview which would direct him in one direction or another. Rather, his decisions regarding monetary policy will come down (as many of his decisions do) to a struggle between three competing forces.

One is a relatively orthodox conservative view that the Fed should take a more constrained and rule-based approach to policy. John Taylor, an economist at Stanford University who helped develop strategies for setting monetary policy based on changes in variables like unemployment and inflation (through what have become known as “Taylor rules”), has been a fierce critic of Fed policy since the financial crisis. His ideas hold sway across the Republican party. At low interest rates (such that monetary easing will tend to consist of heavy doses of unconventional policies like QE), rules-based approaches would likely be more hawkish and less responsive to downturns; certainly Taylorites have urged more hawkish policy over the last few years. The Republican party is also home to a number of gold bugs, who would prefer that the dollar be backed by gold at a fixed parity like in the good old (if ever so slightly depression-prone) days. That would imply a substantially less responsive monetary policy which would be far more likely to induce a deep recession.

Yet Mr. Trump will also hear from “his people,” which is to say businessmen. Businessmen are ideologically disposed toward hawkish policy, but they are also pragmatically interested in a non-crashing economy. They are likely to favor low interest rates and lax financial regulation, but also low inflation and modest wage growth. Should Mr. Trump pay closest attention to this group, future monetary policy would look an awful lot like it has in the past: modestly stimulative, and more focused on keeping inflation in check than in maximizing employment. The two men Trump is said to have chosen to fill vacancies on the Fed board, Randal Quarles and Marvin Goodfriend, seem to fall somewhere between these first two categories: they are respected, conservative economists who are sympathetic to the financial industry, and who also seem to favor a more rules-based approach to policy.

But then there is the most Trumpian force: the President’s impulsive concern for his own self-interest. Should Trump decide that an overly hawkish Fed is undermining his effort to make America great again, his attitude toward monetary policy could swing swiftly and dramatically toward a more dovish position. An embattled White House cannot afford a recession. Neither, we have learned in the saga of James Comey, will Trump be constrained by traditional ideas regarding Fed independence. Certainly Yellen will be aware that her job is far more vulnerable than it would be under a more normal President.

Not that firing will be necessary. The new President will have multiple seats on the Fed’s Board of Governors to fill, including, in 2018, that of Yellen herself. Even if Yellen were to be kept on, she is a consensus seeker, and a Trumpward shift in the board will inevitably influence her sense of appropriate policy.

The longer Trump is in office, the greater the chance that he engineers a major shift in both the policy positioning of the Fed and in its independence. That independence may be destined to erode no matter what. American politics is newly refocused on the welfare of workers and newly willing to use government interventions to improve labor’s lot. Conditions for a fundamental change in the status of the Fed are building. As they weigh up policies like a significantly higher minimum wage and a job guarantee, Democrats should also be thinking about how they would like monetary policy to work.

Ultimately, chronically weak demand, low interest rates, and Fed conservatism will interact, perhaps in the throes of crisis, to create the conditions for regime change. It is impossible to foresee which party will be positioned to win a mandate to remake macroeconomic policy. But the long slump is not going away, and an independent Fed is incapable of dragging America out of it. Just as the experience and the politics of the 1930s shaped postwar policy, and those of the 1970s gave us the economy of the last decade, crisis and stagnation will ultimately yield significant change. It is time to begin making a political case for a different sort of macroeconomic policy.

Read more about Donald TrumpEconomicsmonetary policy

Ryan Avent is a senior editor and the Free exchange columnist at The Economist, and author of The Wealth of Humans.

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