US president Donald Trump has spent quite a bit of time talking about interest rates ahead of this week’s Federal Open Market Committee meeting — and why not, he apparently knows “interest rates much better than they do”.
But core to Trump’s latest tirade, aimed once again Federal Reserve chair Jerome Powell, is a desire to infringe on the independence of the Fed with rate cut demands.
Speaking via video at the World Economic Forum in Davos, Switzerland last week, Trump said he will “demand that interest rates drop immediately” in the US and that they should drop globally.
Of course, Trump has demanded many things since he won a second term in the White House in November: Greenland, the Panama Canal, the list goes on.
Fortunately, Powell and co are unlikely to bow to Trump’s demands. According to CME’s FedWatch tool, the FOMC is likely to keep the Fed Funds target rate on hold at 4.25%-4.5% when it meets this week. In fact, only two cuts are priced in by the market for this year, according to Rabobank — with a single cut even on the cards.
However, Trump’s planned inflationary policies of wide-reaching tariffs and tax cuts puts him on a collision course with the Fed.
In December's FOMC minutes, the Fed warned the “effects of potential changes in trade and immigration policy, suggested that the process [of meeting the 2% target] could take longer than previously anticipated”.
Trump ultimately cannot implement inflationary policies and expect rate cuts — and the Fed knows this. If — or when — Trump and the Fed come to loggerheads, the Fed must push back and assert its independence.
The role of a central bank is to maintain stability in monetary policy and the financial system and to not be a tool for petty politicking. The bank should work on behalf of the economy, not elected officials.
And the market tends to look favourably upon central bank independence. As former Fed vice-chair Donald Kohn noted in 2009, on the day the Bank of England was granted independence in 1997, 10 year Gilt yields fell 30bp despite no changes to its mandate.
Cornerstone
For almost half a century, independent central banks have been a cornerstone of financial stability around the globe. According to Andy Haldane, former chief economist at the Bank of England, there were almost 200 central banks operating at the end of the 20th century, of which 80%-90% were independent.
Of course, independence does not necessarily mean the Fed has freedom to act with impunity. It is still accountable to the US government and ultimately to the US public. But the Fed has shown a willingness to be transparent — this week for instance, the Fed will release a monetary policy statement almost immediately following its latest meeting.
Ultimately, the Fed operates on a long-term mandate. Its chair is appointed by the sitting president every four years, with no apparent term limits. As a result their terms cross administrations.
In fact, in the last 50 years only one Fed chair has served under one president — William Miller, who quit in 1979 after just under 18 months to become incumbent president Jimmy Carter’s treasury secretary, a role he held until Carter’s loss to Reagan two years later.
Powell, meanwhile, has now served three administrations — Trump twice and Biden in between — having been nominated for the role by both presidents, despite Trump’s apparent disdain.
Trump, on the other hand, has taken a liking to short-term thinking. His isolationist decisions to withdraw from the Paris Agreement and the World Health Organisation suggest a leader focussed on the now, rather than the future.
But monetary policy requires longer term thinking. As central banks around the world have found, winning the battle against inflation is not something that happens overnight.
Trump once called Powell “a powerful golfer who can’t score. He can’t putt”. Unfortunately for the commander in chief, it's the long game that counts. The Fed must maintain its independence.