HANALEI, HAWAII – While President Donald Trump’s attack on the US Federal Reserve Board and a sitting governor, Lisa Cook, has prompted expressions of great alarm from economists and commentators, investors responded with a big yawn.
This might seem like a drastic disconnect. However, in reality, both groups have good reasons to respond differently.
Commentators concerned about the stability and integrity of US monetary policy have every reason to be horrified by Trump’s attempt to fire Cook nearly 13 years before his term ended. (For clarity: I directed Cook’s doctoral dissertation at the University of California, Berkeley.) Members of the Board of Governors are appointed to long terms precisely to protect them from political pressure.
Few laws of economics are better established than the proposition that central banks, independent of politics, best implement monetary policy. They generate lower and stable inflation without visible costs in terms of higher and variable unemployment.
There are also plenty of counterexamples, mainly in emerging markets, where a political leader appoints a lackey to run the central bank, and the central bank submits to his whims. As a rule, these episodes turn out to be disastrous. Politicians worry about upcoming elections or public opinion polls and, given power, manipulate monetary policy with short-term goals.
Central bankers, on the other hand, worry about the credibility of the institution and those who run it. Credibility means consistently delivering what they promise. This consolidates expectations and stabilizes economic results. The credibility of the Fed’s commitment to its 2% inflation target is what has solidified inflation expectations in recent years and has allowed policymakers to reduce inflation without a visible rise in unemployment.
Trying to remove acting governors without just cause to replace them with lackeys willing to implement the preferred theory of their political patron does not increase that credibility. This applies to both Trump’s theory that strong economic growth justifies lower interest rates and Turkish President Recep Tayyip Erdoğan’s theory that high interest rates cause inflation.
To be clear, independence does not imply lack of accountability. Nominees for the Board of Governors of the Federal Reserve must be confirmed by the Senate. Its members are regularly summoned to the Capitol to testify.
Still, one has to wonder about this Congress’s willingness to reject a Trump nominee or criticize the policies of a Federal Reserve dominated by him. This raises the worrying possibility that Trump could impose up to three appointments to the seven-member board of governors next year, depending on the Cook case and what Chairman Jerome Powell decides to do when his term expires in May.
Some commentators point out that two board members, Michelle Bowman and Christopher Waller, are already aligned with Trump on the current stance in favor of interest rate cuts. This means that Trump only needs three additional seats to achieve a majority on the Federal Reserve Board, which would allow him to act as he pleases.
That obedient majority can exercise its veto over the reelection of the 12 independent presidents of the regional Reserve Banks, a rotating subgroup of which is part of the Federal Open Market Committee (FOMC), in charge of setting interest rates. At that moment, the domain will be total.
But this means misunderstanding the positions of Bowman and Waller. The FOMC’s decision at its last meeting on whether to cut interest rates or hold them steady, as it did, was very well thought out. The labor market is weakening, which created a strong argument for cutting rates. At the same time, inflation remains stubbornly above 2%, justifying keeping rates stable.
Bowman and Waller are experienced professionals who understand the importance of central bank independence and the value of credibility. His dissent from the last meeting should be considered reassuring, not alarming. It serves as a reminder that whoever Trump appoints to replace Powell cannot assume that the other members of the Board of Directors will simply approve his decisions.
At this point, the optimistic response of the financial markets takes center stage. Even if Trump secures three appointments to the Federal Reserve Board next year, it is far from clear that he will be able to impose his policies. After that, perhaps anything is possible, including more layoffs and questionable appointments. But one year is pretty much the limit of how far investors can look into the future. Financial markets are, to say the least, short-sighted.
The rest of us, however, have a responsibility to look further into the future, as do Congress and the courts. If Cook can be defenestrated, why not others? That’s why Trump’s attack is so alarming.
The author
Barry Eichengreen, professor of economics and political science at the University of California, Berkeley, is the author, most recently, of In Defense of Public Debt (Oxford University Press, 2021).
Copyright: Project Syndicate, 1995 – 2025
