Trump may want to push out Powell, but markets value an ‘independent’ Fed

In addition, the renovation expenses of Fed buildings has overshot the initial budget. This has further given more ammunition to the US President to attack Powell.

Powell as expected is trying his best to keep his composure in this constant trial by both the President and media. What else can the Fed Chairperson do other than take these knocks on the chin and fight on!

Short History of Fed Independence

The ongoing tussle has also brought to fore the ever important question of central bank independence.  Over the years, central bank independence has become a very important topic of discussion and contention.

The government should have goal independence wherein it gives the central bank economic goals to achieve. The central bank should have instrument independence to achieve the stated goals. This goal independence and instrument independence has become the cornerstones of research on central bank independence.

This is not the first time that an American President and the chair of the central bank are having such a verbal spat. American history is littered with conflicts between fiscal and monetary authorities. In 1913, the Federal Reserve was established and remained under the shadow of the government for the next four decades. This was partly due to the fact that central banks being independent was an alien concept with government dominating the affairs. It was also partly due to the two World Wars which pushed central banks towards financing government deficits.

In 1942, the Federal Reserve was also required to keep interest rates on bonds “pegged” to prevent them from rising. Another important reason was personalities and ambitions of US Presidents and their choice of Fed chairs.

Post-WWII, the Federal Reserve began to be worried over inflation. Then FOMC chair Marriner Eccles started mentioning the need to discontinue “the peg” which was not taken kindly by the government. In 1948, then President Harry Truman replaced Eccles with Thomas McCabe as Fed Chair. Though, Eccles continued to serve as a member on the FRB. The Korean of 1950 war further aggravated the inflation situation.

After many deliberations, the government agreed to end the peg in 1951. The Fed Accord of 1951 became the turning point in Federal Reserve independence as the central bank could now freely change interest rates without worrying about government bonds. Subsequent Presidents, Eisenhower and Lyndon Johnson, allowed Federal Reserve to remain independent. Johnson was not happy with fed policies yet reappointed William McChesney Martin as the Chair. This hard earned independence though was short lived.

US President Richard Nixon from 1969-74 wanted the Fed to ease interest rates to push growth and employment. Inflation was already high in US. Yet, Nixon appointed Arthur Burns as Fed Chair who was sympathetic to the idea that inflation was mainly due to the supply factors which rendered monetary policy ineffective. The easier monetary policy coupled with twin oil shocks turned 1970s into the decade of Great Inflation.

The inflation beast was finally overcome when President Jimmy Carter appointed Paul Volcker as the Chair in 1979 who was then also supported by then next President Ronald Reagan.

Since Volcker (1979-87), the subsequent Presidents and Fed chairs have maintained equipoise in their relations. There were differences but it did not become a spectacle. In fact, the 2008 crisis led to the opposite question: Has Federal Reserve got too much independence? The Federal Reserve and other central banks were seen as too powerful and were criticised for allowing the crisis to fester. Even then, the differences did not hit the boiling point.

Way Forward

Coming back to today, how does one see the Trump-Powell conflict? Even though there are parallels with earlier such skirmishes, there are major differences as well.

First, central bank independence especially that of Federal Reserve is taken very seriously by financial markets. The financial markets have reacted negatively to these developments providing a clear signal to the US government to not meddle with the central bank.

Second, Trump cannot fire Powell as is widely speculated. Under the Federal Reserve Act, the US President can only dismiss Fed governors when there is a genuine cause such as inefficiency or negligence of duty. FRB members are appointed for 14 years and within them FRB Chair is appointed for a period of eight years.

Powell was appointed as a full-member in 2014 and Chair in 2018. Thus his term as Chair is till May-2026 and as Board member till 2028. So unless he resigns, he will be Chair till 2026 and remain an influential member in the Board till 2028.

Third, the US economy is doing quite well which is also what the President keeps telling us. The Federal Reserve expects growth to be 1.8 percent and unemployment at 4.2 percent over long term. The immediate worry is inflation which is expected to be above 2 percent in 2025 and 2026 before trending lower to target 2 percent in 2027. There are also expectations that the tariffs and other policies will only lead to higher inflation.  In these times, the focus of the central bank should be on lower inflation which has also been the lesson of the 1970s which was learnt the hard way.

To sum up, even though acrimony with Fed gets the President eyeballs which he constantly seeks, he should avoid unnecessarily treating the central bank and its chair as some kind of an enemy. He will only create more problems for his Presidency which already is facing both ire and fire from both supporters and detractors.