Originally published at Project-Syndicate | Dec 16th, 2024
The past half-century has shown that a competent, independent central bank is the best guarantor of price stability. By vowing to bring monetary policymaking under his control, US President-elect Donald Trump is threatening a pillar of American prosperity.
TILBURG – Back in August, Donald Trump announced that, if elected, he would try to amend the Federal Reserve Act to give the president a larger say in monetary policymaking. Now that he is heading back to the White House, is central-bank independence on the chopping block?
When Trump was out of office and preparing for his next campaign, he argued that the US Federal Reserve’s interest-rate hikes in 2022-23 did not come fast enough to combat inflation. But now that he is president-elect, he argues that the Fed’s rate cuts are proceeding too slowly. “I made a lot of money, I was very successful, and I think I have a better instinct than, in many cases, people that would be on the Federal Reserve or the chairman,” he said in August.
For Trump, monetary policy is all about gut feelings, and one thing his gut has told him to do is fire Fed Chair Jerome Powell, whom he himself appointed in 2017. Powell insists that the president is “not permitted under the law” to fire the Fed chair, but that won’t stop Trump from publicly pressuring the central bank.
Worse, Trump’s chances of getting what he wants have improved now that the Republicans have secured control of both the Senate and the House of Representatives. Even if he fails to force Powell out, he will be able to appoint the next Fed chair when Powell’s term in that role ends in the first half of 2026 (his term as a governor, however, extends until 2028). Judging by Trump’s early cabinet nominations, there can be little doubt that he will choose a loyalist who will do his bidding.
These are worrying prospects, because the erosion of central-bank independence could cost the US economy dearly. The past half-century has generated overwhelming evidence that a competent, independent central bank is the best guarantor of price stability, and that keeping inflation low, and inflation expectations anchored, has massive benefits for the economy overall.
In 1972, US President Richard Nixon successfully persuaded Fed Chair Arthur Burns to adopt policies that would help his re-election campaign. The Fed lowered interest rates even though inflation remained high, which contributed to the stagflation (high inflation and unemployment accompanied by low growth) for which that decade is now remembered. The inflation crisis, triggered by OPEC’s 1973 oil embargo against the United States, raged throughout the 1970s. Not until Fed Chair Paul Volcker hiked rates to 20% in the early 1980s was price stability restored.
Although Powell has signaled that he will not be intimidated by Trump, that does not mean the Fed will retain the same degree of independence that it has today. The Federal Reserve Act is rather vague on the question of whether the president can indeed fire the Fed chair. According to the law, a Fed board member can be removed only “for cause”; but since that is open to interpretation, the case would almost certainly have to be settled by the US Supreme Court.
US judges typically interpret “for cause” to mean fraud or dereliction of duty. One therefore doubts that they would see a disagreement over interest-rate policies as sufficient grounds for the chair’s removal. And even if Trump were to win, he would probably be limited to appointing a new chairman from among the Fed’s current board members.
Nonetheless, even if the US Supreme Court ultimately ruled in favor of Powell, legal appeals and hearings take time, which means that financial markets would be subjected to a disruptive period of uncertainty. And the same goes for any effort by Trump and congressional Republicans to revise the Federal Reserve Act, which would undoubtedly be met by legal challenges.
Trump’s determination to curtail the Fed’s independence should concern us all. Given the immense damage he could do if he does commit his energies to this particular cause, will his economic advisers explain to him that, economically and politically, a further increase in US capital-market rates would not serve his interests? Will they point out that he could just wait for Powell’s term to end, and that the Fed has already embarked on a rate-cutting cycle anyway?
Whatever happens, the promises that Trump has made mean that the US and the rest of the world are in for a monetary roller-coaster ride over the next two years – at least until the midterm elections in 2026. In the meantime, it is more important than ever to revisit the lessons of history. Central-bank independence remains one of the most important factors in keeping prices stable and the economy on track.
Sylvester Eijffinger: Is Professor of Financial Economics at Tilburg University in the Netherlands.
Edin Mujagic: Is a fund manager and macroeconomist at Hoofbosch Investment Fund.