Does an independent Federal Reserve really matter? Experts explain.
President Donald Trump this week said he had discussed with a group of Republican lawmakers the possibility of firing Federal Reserve Chair Jerome Powell, before walking back such plans, calling them “highly unlikely.”
Still, the episode sent stock prices tumbling and bond yields climbing, until Trump’s disavowal restored calm to the markets.
In a rare public rebuke of Trump, several big-bank CEOs stressed the importance of an independent central bank.
“I think the independence of the Fed is absolutely critical,” JPMorgan Chase CEO Jamie Dimon said on an earnings call on Wednesday.
Central bankers beholden to political leaders tend to favor lower interest rates as a means of boosting short-term economic activity, slashing unemployment and generating public support, analysts told ABC News. But, they added, that posture poses a major risk in the possibility of years-long inflation fueled by a rise in consumer demand, untethered by interest rates.
“It’s by now widely agreed, almost all over the world: If you leave monetary policy in political hands, you’ll get too much inflation,” Alan Blinder, a professor of economics at Princeton University and former vice chairman of the Federal Reserve, told ABC News.
“There’s temptation to give the economy juice in the short run,” Binder added. “The costs in terms of high inflation come later.”
Since Trump took office, he has repeatedly urged the Fed to cut interest rates in an effort to bolster the economy.
“We have a man who just refuses to lower the Fed rate,” Trump said of Powell last month. “Maybe I should go to the Fed. Am I allowed to appoint myself? I’d do a much better job than these people.”
Speaking at the Oval Office on Wednesday, Trump offered a different reason for the Fed to lower rates, saying it would reduce U.S. debt-service payments, saving “trillions of dollars in interest cost.”
Trump also slammed Powell for alleged overspending tied to the central bank’s $2.5 billion building renovation project. The Fed attributes spending overruns to unforeseen cost increases, saying that its building renovation will ultimately “reduce costs over time by allowing the Board to consolidate most of its operations,” according to the central bank’s website.
While economists disagree over whether interest-rate cuts are currently needed, the prospect of a politically compromised Fed threatens to drive up inflation expectations as investors fear a cascade of rate reductions and a resulting spike in prices, Wendy Edelberg, director of the Hamilton Project and senior fellow in economic studies at the Brookings Institution, told ABC News.
Widespread inflation worries would prove counterproductive, risking high interest rates because a potential bout of high inflation would eat away at the value of debt payments and require larger sums to make up the difference, Edelberg said.
“If your uncle was lending you money and he thought inflation was going to be really high over the next few years, your uncle would ask for a high interest rate,” Edelberg said.
President Donald Trump and Federal Reserve Governor Jerome Powell at a nomination ceremony at the White House, Nov. 2, 2017.
Xinhua/Yin Bogu via Getty Image
A burst of high inflation in the 1970s and 1980s offers a cautionary tale, some analysts said.
Before the inflation took hold, President Richard Nixon had urged then-Fed Chair Arthur Burns to cut rates in the run-up to the 1972 presidential election. Nixon’s advocacy is widely viewed as contributing to lower-than-necessary interest rates that allowed inflation to get out of control.
Nearly a decade later, in 1981, the Fed raised interest rates as high as 20% in order to bring inflation under control. While the move succeeded in cooling off price hikes, it plunged the U.S. into a recession and sent the unemployment rate to 10%.
“If you’re just eating dessert all the time, you really do have to take your vegetables,” Mark Spindel, chief investment officer at Potomac River Capital and co-author of “The Myth of Independence: How Congress Governs the Federal Reserve,” told ABC News, regarding the need for fiscal prudence.
Though a politically compromised Fed risks economic instability, analysts said, the central bank already faces supervision from elected officials in the form of twice-a-year Fed chair testimony before Congress, and Senate approval for the Fed’s seven-member Board of Governors. Powell, whose term ends in May, was nominated by Trump in 2017 and nominated for a second term by President Biden.
Public scrutiny and government oversight help ensure the Fed serves the interests of the public, Edelberg said.
“I’m absolutely not arguing the Fed should be left to its own devices behind fortress walls,” Edelberg added.