Washington Insider -- Friday

Did the Fed Hold the Economy Back?

Here’s a quick monitor of Washington farm and trade policy issues from DTN’s well-placed observer.

Grassley signs USMCA legislation

Sen. Chuck Grassley, R-Iowa, took to social media Wednesday to announce he has signed the US-Mexico-Canada Agreement (USMCA) in his role in the Senate.

“As President pro tem I had the honor of signing United States Mexico Canada Agreement Implementation Act w my colleagues. This trade agreement will greatly benefit Iowa. Now to Pres Trump for signature,” Grassley tweeted.

Canada has yet to clear the trade deal but is expected to once their parliament returns January 27.

The exact date President Donald Trump will sign the pact remains unclear, with some indications he wants to do it in farm country and with Canadian and Mexican officials present.

Farm Bureau policy plans call for more farmer aid

The American Farm Bureau Federation has set their policy goals for 2020, including another round of trade aid for farmers. “Our members are basically saying, ‘Show us results,’” said Scott VanderWal, the group’s national vice president. He noted that “no products have moved, implementation has not happened yet, and it is kind of a ‘prove it to me’ thing.”

They also are calling for a review of USDA's National Agricultural Statistics Service (NASS) and its crop reporting program, including its methodology and track record. “The June 2019 Acreage report was a debacle, and it seems like each NASS report this year has contained surprises and unexpected market impacts, etc.,” Farm Bureau said.

The group also wants USDA to amend its hemp production framework to allow for plants with up to one percent tetrahydrocannabinol (THC, the chemical in cannabis), compared with the current limit of 0.3%. USDA's interim hemp rule requires “hot” crops to be destroyed at 0.5% THC levels.

Washington Insider: Did the Fed Hold the Economy Back?

The fight over U.S. monetary policy continues on display. On Wednesday, President Donald Trump renewed that criticism from the sidelines of an elite gathering in Davos, Switzerland.

When asked why his economic growth goal was not reached, he said, “No. 1, the Fed was not good,” Data for the full year aren’t isn’t in yet, but probably was 2.2% or 2.3% relative to the fourth quarter of 2018, economists estimate.

The president also pointed to the grounding of Boeing’s 737 Max plane and severe storms as factors that held back the economy, but added that “with all of that, had we not done the big raise on interest, I think we would have been close to 4%.”

Economists said that claim was not realistic.

The central bank’s nine interest rate increases between 2015 and late 2018 — three of which it reversed last year — probably reined in business investment and the housing market, economists say. But that impact did not shave nearly 2 percentage points from growth.

It discussed “a few ways to think through how the economy might have shaped up had the Fed acted differently.”

In the “real world,” the Fed lifted rates between December 2015 and the end of 2018 in an effort to achieve a soft landing in which growth continued at a moderate pace and inflation settled around its 2% target. When growth showed signs of wavering in 2019 and inflation remained soft, Fed officials reversed course, cutting rates three times.

In what it called the “most extreme counterfactual,” one in which the Fed never raised its policy interest rate at all, growth might have been 1 percentage point higher in 2019, said Ernie Tedeschi, policy economist at Evercore ISI.

That estimate, based on the central bank’s main economic model, would have gotten America to around 3.2% growth in 2019 — but at a hefty cost. For example, “Inflation would’ve been well above their mandate, 2.5% and rising, at this point,” Tedeschi said, and “would have necessitated a sharp increase in rates.” Such an abrupt change could have weakened the economy and certainly “would have been painful,” he said.

But even in that version of the world, one in which the Fed was willing to leave its policy totally untouched at near-zero for more than a decade, the economy could have achieved that 4% growth figure only absent a trade war — and even that is a stretch, the Times said.

While it’s hard to gauge precisely how much the administration’s tariffs reduced growth, estimates suggest they could have shaved between 0.5% and 1 percentage point away in 2019, Mr. Tedeschi said.

All of these projections are highly uncertain and even if the basic figures are right, “this scenario is unrealistic,” the Times said.

In another version of the world, the Fed could have raised interest rates between 2015 and 2018, but then lowered them much more quickly in 2019. Had the federal funds rate dropped to zero at the very start of the year, Tedeschi said, it might have added about 0.35 percentage point to growth, getting the economy up to the 2.5% range.

However, that is seen as far-fetched since the Fed has never slashed rates to zero outside of a recession.

Doing so at a time when the economy was growing and the president pushing for more stimulus would have looked overtly political and could have raised the risk of higher inflation. Relative to the economy’s structural growth path — the one driven by labor force expansion and productivity — the Fed’s rate-setting may have shaved about 0.1 percentage point from growth in 2019, according to an estimate from Julia Coronado, a founder of MacroPolicy Perspectives. Slower capital expenditures and trade probably shaved another 0.1 percentage point from growth. But those effects were offset by the aftereffect of ramped-up government spending and tax cuts, which she estimates probably lifted growth by about 0.4 percentage point.

But even here, there are uncertainties.

While it is clear that business investment fell sharply last year and manufacturing sagged, weighing down growth, it is hard to tell how much of that was a lagged response to higher interest rates and how much was a response to the trade war.

“The slowdown in capital expenditures came along when the trade war escalated,” Torsten Slok, an economist at Deutsche Bank, said in an interview. “One cautious estimate is that the trade war played a bigger role,” he said.

Tax cuts and higher government spending have helped to nudge growth temporarily above its potential — it came in at 2.8 percent in 2017 and 2.5 percent in 2018, decently above the roughly 2 percent sustainable growth rate.

Yet those gains probably will not hold. The working-age population is growing more slowly, and productivity, which popped temporarily, has since fallen back to earth. The Congressional Budget Office estimates that over the next decade, growth will average 1.9% a year, up slightly from the preceding decade but down substantially from the 3 percent and higher growth that prevailed before 2000.

So, we will see. “We haven’t seen 4% growth for many, many years,” Slok said. Certainly, this continuing fight over monetary policy should be watched closely by producers as it intensifies during the coming campaign, Washington Insider believes.

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