The prospect of Donald Trump returning to the US presidency is generating concerned speculation: What if he exerts more control over the Federal Reserve, undermining the independence that has been crucial to containing inflation and to keeping the world’s largest economy on an even keel?
It wouldn’t be easy. That said, it’s a truly frightening prospect.
When central banks have greater independence in setting monetary policy, they’re more successful at achieving the employment and inflation objectives set by their legislatures. Yet Trump has often expressed frustration with the presidency’s lack of influence over interest rates, and some of his allies have reportedly produced a plan that could involve firing Jerome Powell as chair of the Federal Reserve Board of Governors and subjecting the Fed’s decisions to greater White House review.
Could Trump do it? By design, it’s difficult to gain much control over the Fed during any four-year presidential term. The president appoints just seven out of the 12 voting members of the policy-making Federal Open Market Committee, and those on a staggered schedule. Only two will come up between 2025 and 2029: Powell and Governor Adriana Kugler, a Biden appointee. Moreover, if Trump sought to install more compliant replacements, he’d still need Senate approval. In his first term, two of his four proposed appointees — Stephen Moore and Judy Shelton — didn’t get through.
Firing Powell would be tough, too. There’s no precedent, and if Trump nonetheless managed it, Powell could continue as a governor until his term ended in 2028. What’s more — and I emphasize this — the members of the FOMC could vote to reinstate him as the committee chair.
Still, the very thought that Trump might try is worrying enough. Even if one sets aside the likely preferences of a real estate developer as president, the government has some powerful incentives to prefer lower interest rates. Most notably, higher inflation would boost economic growth in nominal dollar terms. This, in turn, would suppress the country’s debt-to-GDP ratio, masking the unsustainable trajectory of US fiscal policy, with budget deficits on track to exceed 6 percent of GDP indefinitely. The inflation associated with the pandemic, for example, reduced marketable debt held by the public to 92 percent of GDP, from a peak of 103 percent in 2020.
Even without controlling the Fed directly, the president and Congress can exert a lot of pressure. By pursuing a profligate fiscal policy, they can complicate the central bank’s task of controlling inflation: The more it increased interest rates, the worse the fiscal problem would become as the government’s debt-servicing costs rose. Taken to the extreme, such fiscal dominance can result in hyperinflation as the central bank prints money to finance government expenditures, as happened in Zimbabwe in 2007 and Germany in the early 1920s.
The dollar has become the world’s reserve currency and a stable store of value thanks to prudent economic management, a strong rule of law, deep and liquid capital markets and free movement of capital. If efforts to control the Fed threatened these key attributes, the dollar would likely weaken, stock markets would decline and risk premia on US fixed income assets would increase, impairing the country’s economic health. This could happen even if Trump tried and failed to curb the Fed’s independence, but it would be much worse if he succeeded.
The relaxed market sentiment about the upcoming presidential election surprises me. Hard as it might be to take indications of Trump’s intentions for the Fed literally, they must be taken seriously.
Credit: Bloomberg
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