Past history suggests Trump will get some slack, interest rates will go down, Powell will move on, and, unfortunately, inflation will rise again sooner or later.
I n a widely anticipated move last week, the Federal Reserve’s Open Market Committee (FOMC) voted to reduce short-term interest rates by one quarter of a percentage point. It was the first cut since December 2024 and likely one of several over the next six months. Will President Trump, who wants to see rates fall by 3 percentage points, be satisfied?
To have his way, Trump seeks more control over the twelve-member FOMC. Is central bank independence headed down the drain . . . again? Does it matter?
Even if Fed independence is more myth than truth, it may still be a useful one.
Trump’s long-running effort to control the FOMC now includes (1) threats to fire Chairman Jerome Powell, (2) the appointment of his Council of Economic Advisers chairman, Stephen Miran, who called for a larger cut last week, and (3) a disputed effort to fire Lisa Cook, one of the seven Fed governors who make up part of the FOMC. Cook participated in last week’s meeting and voted for the quarter-point cut.
If Trump’s bullying succeeds, the worst outcome would be more printing-press money and more inflation than the 2 percent per year that, strangely enough, has become accepted as okay (and for which former Fed chairman and renowned inflation-fighter Paul Volcker said, “I know of no theoretical justification”). Fear of the possibility has generated a virtual anvil chorus of concern about Fed independence, which, going back to the Treasury-Fed Accord of 1951, theoretically shuts the door on presidential or political interference.
It’s helpful to remember that the accord emerged in conditions somewhat like those we face now. Former Fed economist Robert Hetzel and former Fed official Ralph Leach tell the story of a president, Harry Truman, who wanted to keep interest rates low; an opposing Fed chairman, Thomas McCabe, who was worried about inflation; and a Treasury secretary, John Snyder, who sided with the president and would eventually provide the next Fed chairman, William McChesney Martin, from his staff.
The agreement emerged following World War II. During the war, the Fed had pegged interest rates at a low level to accommodate Treasury’s bond auctions and ease, or at least disguise, the cost of winning.
In effect, the Fed had already generated a surge of printing-press money. CPI inflation rose to 17.6 percent in June 1947 and then sagged. As the Korean War ensued, inflation surged again and hit 21 percent in February and the advent of the Korean War in 1951.
As a result, Truman imposed wage and price controls and argued that the Fed should keep interest rates low to avoid imposing losses on holders of war bonds. McCabe thought otherwise. Truman went so far as to order an FOMC meeting at the White House, something Trump has not tried yet. McCabe was mortified. The meeting occurred.
In the final count, the Fed held its ground but offered temporary interest rate pegs to accommodate Treasury. The accord came into being. It was not a pretty story, but inflation fell for a while and Americans were better able to maintain their prosperity. McCabe resigned.
But, of course, that was not the end of the story. Economist Jonathan Newman’s review of the accord led him to conclude that the Fed’s independence was more mythical than factual.
As Newman sees it, the Fed’s behaving as if it is independent from political influence has been more the exception than the rule. Every economic crisis brings cooperation with the White House or Treasury to soften the blows. Take, for example, 9/11, the 2007-2009 financial collapse or the 2020 Covid crisis.
John F. Kennedy’s efforts to manage the Fed went so far as to propose making the Fed chairman a cabinet member. Richard Nixon practically arm wrestled with Chairman Arthur Burns until he agreed to increase the flow of money in the economy, and with it, inflation. But LBJ, in 1964, actually got into a shoving match with Fed chair William McChesney Martin in a struggle to bring down interest rates. This century’s financial collapse led Chairman Ben Bernanke to join hands with Treasury Secretary Tim Geithner to prevent a national banking panic.
Even so, some myths may be worth preserving. The political convention of Fed independence anchors us to an important starting point — maintaining the purchasing power of the dollar — even if that position will sometimes be compromised by politicians who think there are better ways to preserve hard-earned prosperity.
Throughout history, kings, kaisers, dictators, and presidents have wanted control of the money supply — be it gold, silver, or paper — to spend their way out of economic problems. Few, if any, are willing to be bound too tightly to the mast and reject calls for relief from an imperfect economy — or for more, more, more — and be removed from office.
Past history suggests Trump will get some slack, interest rates will go down, Powell will move on, and, unfortunately, inflation will rise again sooner or later. With nothing backing the dollar but convention, the Fed roller coaster ride will continue.