How does the Federal Reserve work, and why is Donald Trump trying to change it?

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Donald Trump wants to bend the US’s independent central bank to his will.

The president has derided Jay Powell, the Federal Reserve’s chair, as “stupid”, a “numbskull” and a “moron” and called on him to resign. 

He is also trying to sack Lisa Cook, a member of the Fed’s board of governors. This is part of what analysts and Trump critics describe as a push to take control of the institution.

Why does the Fed’s independence matter?

The Fed is the institution tasked with supervising banking, moderating inflation and conducting monetary policy — the last via the 12-member Federal Open Market Committee (FOMC). It has a dual mandate from Congress to “promote maximum employment and stable prices”.

Given the US economy’s size and the dollar’s status as the leading reserve currency, any erosion of the bank’s independence would be felt globally.

Didn’t Trump pick Powell in the first place?

Yes. While Barack Obama originally appointed Powell as a Fed governor, it is Trump who nominated him as chair during his first term in 2017. But the relationship soured quite soon after the new chair took office in February 2018. Since Trump took office for a second term this year, has made it clear that he wants Powell, whose four-year term ends next May, replaced:

There was also this cringe Trump-Powell encounter when the Fed chair took the president on a tour of the central bank’s headquarters:

Independent-minded members of the board of governors, including Powell, currently outnumber the ones seen as following Trump’s will. But the US president is piling pressure on the bank.

The FT’s Claire Jones, who wrote this sharp analysis back in July, says this: 

There are a lot of guardrails in place at the Fed, but they can be tampered with. This has shone a spotlight on just how much independence there is at the most important central bank in the world.

Who governs the Fed?

The Fed is controlled by a seven-member board of governors. Board members are appointed by the president to 14-year terms, but not all serve them out. Their terms are staggered so that one expires every two years, making it harder for any president to replace the entire board.

The US also has 12 regional Fed banks. Each bank’s board appoints their president, subject to the approval of the Fed’s board of governors.

Can Trump replace the Fed board?

Trump loyalists do not control the board. But this could change by May, when Powell’s term ends, if not sooner. Of the seven governors, three — Michelle Bowman, Christopher Waller and Stephen Miran are Trump appointees. And though Powell is a Trump appointee too, the president has made it clear he wants him out.

Miran joined the board in September, after Adriana Kugler, a Biden appointee, abruptly resigned Trump is also trying to get Cook sacked, following allegations from one of his allies that she committed mortgage fraud, which she has denied. 

The Supreme Court this month declined to let him do so until the justices heard oral arguments in the case.

Would a new Fed board let Trump control rates?

Even if Trump were to get a majority of loyalists on the board, this wouldn’t immediately let him set lending rates, which are decided by the FOMC.

The body has 12 voting members. The Fed’s seven governors sit on the FOMC; the other five comprise the New York Fed president and four representatives chosen from the 11 other Fed banks on a rotating basis. 

But by what one economist calls “a quirk of bad institutional design”, all 12 of the Reserve Bank presidents’ terms expire simultaneously every five years; this will next happen on February 28, 2026. The Fed board has the authority to veto Reserve Bank presidents, so as Adam Posen of the Peterson Institute for International Economics explains:

The upshot is that if Trump can get a four-person majority on the Fed board before February 28, then he can rapidly get control of the FOMC as well.

Lev Menand, an associate professor of law at Columbia Law School, says that the 12 Reserve Bank presidents have in the past sometimes been powerful dissenting voices at FOMC committee meetings. But, he says, a future Trump-controlled Fed board could exercise its leverage to pressure them “if the board were determined to get the Reserve Bank representatives into line”.

What if Trump gets control of the FOMC?

In some of his remarks attacking Powell in July, Trump said this about interest rates:

We should be at 1%. We should be less than 1%.

Economists have warned that cutting rates this low would rattle bond market investors, who might price in greater inflation risk, prompting them to demand higher bond yields.

One indication of how far off the Fed’s current consensus a Trump-controlled board might go was seen at the latest FOMC meeting, when the body cut the federal funds rate by 25 basis points to 4 to 4.25 per cent.: Miran, the newest Trump appointee, was the outlier, casting the sole dissenting vote for a 50bp cut.

The White House could also in theory try to amend the Federal Reserve Act, using its Congressional majority.

What else might a Trump-controlled Fed do?

Analysts say Trump might use greater power at the Fed to loosen banking rules and promote cryptocurrency. In March the president signed an executive order to establish a “Strategic Bitcoin Reserve and US Digital Asset Stockpile”.

Posen says this:

I’m more alarmed about the loss of Fed independence damaging financial stability than I am about inflation. 

Animation by Ian Bott

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