Introduction to the Conflict
The relationship between the United States President Donald Trump’s administration and the Federal Reserve (Fed) has reached a critical point. After a year of rising tension, the conflict has escalated sharply, with the president criticizing the Fed’s interest-rate policy and making personal attacks against the Fed Chairman, Jerome Powell. The situation has become so intense that it has drawn attention from the rest of the world, and many are warning that what happens in the US may not stay there.
The Feud Begins
The feud between Trump and the Fed started during Trump’s first presidency, shortly after he appointed Jerome Powell as the Fed’s chairman in 2017. However, it has escalated significantly since Trump’s return to the White House. The president has mixed criticism of the Fed’s interest-rate policy with personal attacks against Powell, creating a hostile environment for the central bank.
The Department of Justice Gets Involved
The situation took a dramatic turn when the Department of Justice (DOJ) served the Fed with subpoenas, raising the specter of an unprecedented criminal indictment of a sitting Fed chief. Powell responded with a video message, framing the DOJ investigation as a transparent attempt to subvert the US central bank’s independence. He emphasized that the Fed’s ability to set interest rates based on evidence and economic conditions is at stake.
The Importance of Central-Bank Independence
The spotlight on the Fed has highlighted the importance of central-bank independence. A bipartisan group of former policymakers, including former Fed chairmen Ben Bernanke, Alan Greenspan, and Janet Yellen, released a statement arguing that prosecutorial attacks on the Fed have no place in a country that values the rule of law. They warned that an attack on central-bank independence is an attack on a pillar of economic well-being.
International Reaction
The conflict has also drawn international attention. A group of leading central-bank governors, including the heads of the Bank of Canada, the Bank of England, and the European Central Bank, released a joint statement affirming their solidarity with the Fed and Powell. This move defied the long-standing norm of non-interference with the domestic affairs of other countries.
Potential Consequences
The feud between the Trump administration and the Fed has significant implications for the US and global economies. If the conflict is not resolved, it could lead to a "fortress Fed," where officials may feel compelled to run policy in a manner that explicitly resists political pressure, potentially oversteering in the opposite direction. This could result in unanchored inflation expectations, macroeconomic instability, and heightened financial volatility.
Checks and Balances
Fortunately, there are internal and external checks and balances in place to prevent worse outcomes in the US. The structure of the policy-setting Federal Open Market Committee (FOMC) limits the extent to which the chairman can bend the collective will toward political ends. Additionally, the scars from the Great Inflation of the 1970s remain, and reining in inflation and re-anchoring inflationary expectations was an extremely painful process that remains seared into the collective memory of Americans.
The Role of Markets
Markets can also play a significant role in responding to and impacting policy. The UK’s experience with Liz Truss’ volatile 49 days as prime minister in 2022 demonstrates the power of "bond-market vigilantes" who can effectively walk away from what they perceive as reckless policy.
Conclusion
The conflict between the Trump administration and the Fed is a critical issue that requires attention and resolution. The first step must be to offer an "off-ramp" for both Trump and Powell, allowing for deescalation and a return to a more constructive relationship. It is essential to reaffirm the importance of a Fed that is not only independent but also pursues operational reforms, is held accountable for its performance, and embraces a more strategic policy approach. Ultimately, the goal should be to transform this feud into something constructive, ensuring the long-term stability and prosperity of the US and global economies.
