There are two big events that will help define the 2016 presidential race. The first takes place Wednesday night with the second GOP primary debate. The second happens Thursday with the Federal Reserve‘s announcement on interest rate policy. Of the two, the Fed’s call is the most important.
Because if Janet Yellen and the central bank make a mistake and move too fast to raise rates—or continue to send mixed messages that markets don’t really understand—it could cause further turmoil and wind up slowing down the U.S. economy in ways that could prove fatal to the Democratic nominee.
Already, leading liberals are pressing Yellen and the Fed hard to wait and not raise their benchmark rate at this week’s meeting, arguing that to do so could cause unemployment to rise again and snuff out nascent gains in workers’ take-home pay.
The campaign is particularly troublesome for Yellen because she owes her job, in large part, to progressives who revolted against President Barack Obama‘s first choice for the Fed chair position: former Treasury Secretary Larry Summers. Some on the left now say if Yellen moves to raise rates this month she would be betraying her strongest supporters while potentially making it much more difficult for Hillary Clinton—or Bernie Sanders or Joe Biden—to hold onto the White House next fall.
“I was excited when she was nominated,” Ady Barkan, leader of the progressive group Fed Up, told Politico, adding that it is “a huge moment” for Yellen to “to display real leadership.”
On the other side of the debate are many economists who argue that the time is long past for the Fed to boost rates for the first time in more than nine years with unemployment at just 5.1 percent amid signs of labor market tightening that could accelerate quickly and put significant upward pressure on wages and prices.
“The economy … can cope with higher rates, and needs them, given the tightness of the labor market,” Pantheon Macroeconomics’ Ian Shepherdson said in a note to clients Monday.
Yellen herself has repeatedly indicated a desire to raise rates this year only to hold back at every meeting as international market turmoil, a slowdown in China and the rest of the developing world, and mixed U.S. economic data clouded the picture.
But from a purely political perspective, Democrats should probably be hoping the Fed does raise rates this week.
Because if the central bank waits until December—the next meeting after September with a news conference—it could wind up having to make bigger and faster hikes that could be even more disruptive to a U.S. economy already growing at less than 3 percent.
“The paradox is that by avoiding difficult and potentially disruptive decisions in the short term, the Fed is raising the risk that future actions will be unavoidable, more aggressive and, hence, more damaging,” Shepherdson wrote.
If the Fed moves this week, this argument goes, it might cause a day or two of market dislocation as traders and investors adjust to the new policy environment. But it should not be a major blow, as rates will probably stay quite low. This will be especially true if the central bank uses its statement and Yellen uses her news conference to reassure markets that the pace of hikes will be very slow and would stop at any sign of deflation or economic stall out.
By contrast, if the Fed waits and inflation starts to rise, Yellen could be forced into more and faster hikes. This is the “rip the Band-Aid” off approach in which Democratic hopefuls—and the economy—might take some short-term pain in return for longer-term gain. A dislocating hike in September 2015, this theory goes, would be much better than a series of sharper and more painful increases in December and throughout the 2016 election year.
Republicans, meanwhile, have little to lose no matter what the Fed decides. Even if Yellen and the central bank pull off a seamless return to more normal interest rate policy the economy is not likely to be rocketing ahead in 2016. Widespread dissatisfaction with the direction of the nation is likely to remain a favorable issue for the eventual GOP nominee and make life harder for Democrats seeking to holding onto the White House for a third consecutive term.
And if the Fed blows it, the path to the White House will get even easier for Republicans.
The problem the GOP has is not how the economy is faring, it’s who they nominate. Wednesday night’s debate will offer the Republican field another shot at slowing the momentum of bombastic billionaire Donald Trump who now leads the field at 33 percent in the latestWashington Post/ABC News poll. Retired neurosurgeon Ben Carson is second with 20 percent. One-time front-runner Jeb Bush is mired in third with just 8 percent.
Trump now fares pretty well against Clinton in some general election match-up polls. But Democrats are salivating at the prospect of actually running against Trump, whose comments about women and immigrants and penchant for highly controversial remarks would provide powerful fodder for attacks while driving turnout for key Democratic constituencies.
Wednesday’s debate will be critical for Bush—and Scott Walker and Marco Rubio and the rest of the GOP field—to land real blows on Trump and start to turn around his momentum. Because if they don’t, even a Fed disaster might not be enough to help them regain the White House.