Powell takes a cautious wait-and-see approach as the market worries about "Trump 2.0" and the Federal Reserve making mistakes again

According to the Zhitong Finance APP, Federal Reserve Chairman Jerome Powell stated that he wants to first observe what policies the incoming Trump administration will implement before predicting the impact of those policies on the economy.

Powell said at a press conference on November 7, "There is nothing to simulate right now. We do not guess, we do not speculate, and we do not assume."

Powell's cautious wait-and-see approach differs from 2016

The Federal Reserve's response is different from when Trump first won the U.S. election in 2016. Meeting minutes from that time show that a month before Trump's inauguration, Fed staff began predicting that fiscal stimulus would boost economic growth, although some of that would be offset by higher interest rates, based on the assumption that promised tax cuts would be passed. Several policymakers, including Powell, also incorporated changes in fiscal policy into their forecasts.

"More accommodative fiscal policy may be introduced in 2017," Powell, then a Fed governor, wrote in his forecast comments submitted at the December 2016 Federal Open Market Committee (FOMC) meeting. "Therefore, I follow the staff's baseline assumption and set the personal income tax cut at 1% of GDP as a placeholder."

He also indicated that he had changed his interest rate forecast to three rate hikes in 2017 instead of two 25 basis point hikes.

Given that Trump's policies are expected to reignite price pressures, and with Fed officials still struggling to end the most challenging inflation cycle in forty years, Powell's caution compared to 2016 is striking. How much further the Fed can lower interest rates still partly depends on how officials view the impact of tax, tariff, and immigration policies on the economy.

Former Fed governor and University of Chicago Booth School of Business economics professor Randall Kroszner stated that the "work to contain inflation is not yet complete," and that deregulation and business-friendly tax policies could boost the economy. In the short term, as the U.S. economy is bolstered, the Fed's path for adjusting interest rates is likely to be more gradual.

The Fed may make mistakes again

For Fed officials, how and when to act around fiscal stimulus is fraught with political risk. If they raise rates too early or too high to offset the impact, they could be criticized for going against government policy. If they raise rates too little or too late, inflation could heat up as it did in 2021.

Eight years ago, it was difficult to accurately predict the impact of the policies proposed by Trump. The Fed ultimately began cutting rates in July 2019, just 19 months after Trump's tax cut plan was passed, in response to a manufacturing slowdown and inflation falling below the 2% target.

Former Fed governor Laurence Meyer believes that Fed officials "should conduct alternative simulations" to understand the economy's performance after tax cuts. "They should not make policy based on things they do not know."

However, others worry that if the Fed reacts slowly, it may make mistakes.

Trump has once again promised to lower taxes, and with control of both the House and Senate, he may extend tax cut policies.

Brookings Institution senior fellow Sarah Binde stated, "The unified control model we see from the Republicans right now is not a restrained model. I can understand why Fed officials might want to avoid the wind and better understand what will happen in the future "But there is indeed a risk of falling into difficulties."

Several Wall Street banks are already eager. Since Trump won his second term, economists at JP Morgan, Barclays, and Toronto-Dominion Bank have reduced their forecasts for interest rate cuts next year. Investors have also lowered their expectations for rate cuts in 2025.

Kyle Pomerleau, a senior fellow at the American Enterprise Institute, stated that at the end of 2016, it was "a very reasonable assumption" that Congress would pass a personal income tax reduction bill and stimulate demand.

He noted that this time, taking the same measures may be less reasonable. He said, "There is less consensus within the Republican Party on what should be done. The deficit is higher."