Report

Fed Rate Hike Sets Up Showdown With Trump

It's going to be more expensive to borrow money in Donald Trump's America.

Andrew Burton/Getty Images
Andrew Burton/Getty Images

For just the second time in a decade, the Federal Reserve voted Wednesday to raise the cost of borrowing from the U.S. Central Bank, making it more expensive for President-elect Donald Trump to implement his bold plans for the American economy.

The Fed’s Open Market Committee increased rates a quarter point, from .5 percent to .75 percent, signaling optimism the U.S. economy is strong enough to withstand a small uptick in the cost of borrowing. And the Fed is poised to raise rates again next year.

The even slightly-surging economy brings the end of an era of cheap borrowing. For the bulk of the Obama administration, interest rates hovered close to zero — an incentive for people to take loans to make purchases, and in turn, spurring economic growth.

And so Trump, who has accused U.S. Federal Reserve Chief Janet Yellen of playing politics with policy to benefit Obama, no longer has the free-money tool at his disposal. He will enter office next month after promising to boost the U.S. economy with 4 percent growth and create 25 million new jobs — two claims many experts find dubious.

The businessman-turned-politician also must contend with a surging U.S. dollar, which makes it more expensive for foreign consumers to buy American products. Without an increase in exports, it will be difficult for Trump to lower trade deficits and bring back the manufacturing jobs he’s promised.

The President-elect is inheriting a robust economy from President Barack Obama. More than 14 million jobs have been added since the end of the Great Recession in 2009. Under Obama, GDP growth has averaged about 2 percent annually. Unemployment is now at 4.6 percent, down from 10 percent in 2009.

Trump plans to achieve 4 percent GDP growth by gutting regulations to rein in Wall Street after the 2007-2008 collapse of the subprime mortgage bubble, the root cause of the recession. He wants to cut taxes on corporations and for American consumers. Trump also plans to spend trillions of dollars on American infrastructure improvements in hopes of creating jobs while improving U.S. roads, bridges, and airports.

Asked whether the president-elect’s proposals influenced the rate hike, Yellen said, “Some of the participants, but not all of the participants, did incorporate some assumptions of the change in fiscal policy into their projections. That may have been a factor that was one of several that occasioned these shifts.”

Trump can’t remove Yellen when he takes office; her tenure doesn’t end until 2018, and he doesn’t have the power to fire her. He could decline to renew her term, breaking tradition with the last three Fed chairs, who were all reappointed.

The decision to raise rates, which was widely expected, was unanimous. Over the course of the last 10 years, the Fed has been reluctant to make cash more expensive because it feared it would be a disincentive to spend as the economy slowly recovered from the 2008 crash that threatened to sink the global economy.

The Fed last raised interest rates a year ago. Before that, it was essentially free to borrow from the central bank. The Fed is also eyeing three more rate increases in 2017. That means that after a decade of free money, the central bank plans to make loans more expensive three times during Trump’s first year in office.

So far, Wall Street has cheered Trump’s proposals. The Dow Jones industrial average is at its highest levels ever, flirting with 20,000 points. Deregulation and a more favorable tax code could compel businesses to spend some of the $1.4 trillion in cash they are currently sitting on, bolstering the overall economy. The stock market’s immediate reaction to the rate hike — the Dow briefly hit another all-time record high after the Fed’s announcement before retreating — indicates that an increase to the cost of borrowing might not be enough to derail the post-election bull market.

“Yes, it still could all end very badly. The world is a risky place. If global growth collapses, U.S. growth could suffer severely,” Harvard economist Kenneth Rogoff wrote in an analysis circulated Wednesday for the World Economic Forum. “Still, it is far more likely that after years of slow recovery, the U.S. economy might at last be ready to move significantly faster, at least for a while.”

Photo credit: ANDREW BURTON/Getty Images

David Francis was a senior reporter for Foreign Policy, where he covered international finance. @davidcfrancis

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