Who Should Make US Monetary Policy?

The Federal Reserve headquarters in Washington on March 21, 2023. Kevin Dietsch/Getty Images

Commentary

Although these articles almost always focus on China trade and economics, Donald Trump’s comments on the subject of the Federal Reserve (Fed) independence demand a perspective.

Some see Trump’s desire for a presidential role—formal or informal—as a break from past practice and an affront to the long-held belief that the Fed should have complete independence from political pressure.

Historically and practically speaking, however, presidents have always had tremendous influence on monetary policy. What Trump seeks, whether wise or not, would hardly be much of a practical departure from that past.

At a recent press conference, Trump, in response to a reporter’s question about how monetary policy is decided, said: “The president should at least have [a] say.” The former president then added, “I feel that strongly.” It also came out that Trump wants to give the president power to fire the Fed chairman at will. Presently, that power only comes at the end of the Fed chairman’s four-year term.

Since then, Trump has softened this position, saying: “A president certainly can be talking about interest rates.”

These Trump positions have elicited considerable comment from economists, policymakers, and legal experts. All the commentary, whether it objects to the proposals or not, notes that the Federal Reserve Act of 1913 explicitly gives the Fed complete independence from political control. The act enshrined this independence over concerns about inflation. Because politicians prefer lower interest rates and easy monetary policies in order to promote growth, jobs, and votes, it was thought that their influence would lead to chronic inflation. The objections to Trump’s proposals center on this same concern.

Whatever the law’s intent, history shows that there has always been a presidential influence on the Fed. The U.S. Treasury, not the Fed, controlled monetary policy during the two world wars, meaning there was direct control from the White House. The appearance of Fed independence was only reestablished in 1951 when the so-called Treasury-Fed Accord separated Fed policy from government debt management. Prior to this, the Treasury all but set interest rates on its debt issues and, in so doing, set rates generally in banking and in financial markets. The accord ended this practice.

For a while after the accord, it must have seemed as though the Fed really had secured independence. The great growth and low inflation of the 1950s and 1960s obviated any need for political pressure on the Fed. But when signs of inflationary pressures appeared in the late 1960s, and the Fed raised interest rates to counter them, the Nixon White House leaned against the action, so much so that at the first signs of economic weakness in 1970, the Fed yielded to the pressure even though inflation continued to accelerate. In 1971, when Nixon put wage-price controls in place, the political side of the equation used them to insist that the Fed need not use monetary restraint. And the Fed complied. The inflation subsequently got worse.

Although wage-price controls failed and were lifted, the pattern was set for the rest of the decade and into the 1980s. President Jimmy Carter leaned on the Fed to moderate monetary restraint in the mid-1970s to avoid a recession. The Fed complied. As it turned out, the United States got both a recession and still more inflationary pressure. The pattern only stopped in the early 1980s, when, in a rare move, Fed Chairman Paul Volcker ignored the White House and insisted on anti-inflation monetary restraint even as the economy fell into recession.

Nor has the pattern of presidential influence disappeared. In 2018, President Trump pressured Fed Chairman Jerome Powell to halt the Fed’s efforts to raise interest rates to levels the Fed considered “normal.” Trump wanted Powell to cut interest rates. Powell resisted at first but yielded in 2019. The chairman said at the time that the cuts were not in response to presidential pressure but rather part of an effort to ward off the economic effects of the tariffs placed on Chinese imports. The tariffs could best be described as a pretext, for any economic fallout would have been inflationary and required rate increases, not the cuts the president wanted and Powell delivered. Ultimately, the COVID-19 pandemic required dramatic interest rate cuts that overshadowed this example of presidential influence.

The White House’s influence on monetary policy was again evident in 2021, when Powell adopted White House talking points on the worsening inflation picture emerging at the time. Insisting along with the White House that the inflation was “transitory,” Powell refused to institute anti-inflationary monetary restraint. His position was politically delicate. His term as chairman was ending, and he wanted President Joe Biden to reappoint him. Once he received that reappointment, he abruptly changed to anti-inflationary monetary restraint in March 2022.

Against such a record, talk about Fed independence sounds like a legal fiction. As should be clear, presidents have long had a powerful influence on monetary policy, whatever the Federal Reserve Act of 1913 says. Trump typically talks about things in terms of himself, but what he wants is hardly a departure from past practice by almost every president. Even if he were to take the White House, any formal change in the arrangements would be highly unlikely. The Fed, after all, is a product of Congress.

Changing the 1913 Act would require a vote that would be contentious, to say the least. Getting it through would require Republican majorities in both houses and more discipline than the party likely can muster. The whole flap about the independence issue—whether pro or con—is closer to political than policy posturing.

Views expressed in this article are opinions of the author and do not necessarily reflect the views of The Epoch Times.