On September 16 and 17, the Federal Reserve’s Federal Open Market Committee (FOMC) met to discuss monetary policy in the United States, as it does eight times a year. This included setting the all-important federal funds rate that banks charge each other to meet their reserve requirements—done in accordance with the Fed’s congressional mandate “to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”
Although the committee ultimately voted to lower the federal funds rate by a quarter point, the meeting drew particular attention because of the Trump administration’s repeated attempts in the preceding months to influence the Fed’s decision. Those actions included threats to fire Federal Reserve Chair Jerome Powell if he didn’t lower the rate, the attempted firing of Fed Governor Lisa Cook based on likely insufficient grounds, and the appointment of Stephen Miran for a separate opening on the board of governors, even though Dr. Miran publicly stated that he would retain his position in the administration by taking unpaid leave while serving at the Fed. Notably, Dr. Miran cast the sole vote in opposition to the quarter-point rate reduction, because he thought it should be lowered further.
While the FOMC meeting is over, the administration’s actions will continue to pose a threat to the independence and credibility of the Federal Reserve. This is an appropriate time to remember why and how the Fed is structured to maintain its independence and how it is nevertheless accountable to the public.
What is the Federal Reserve’s role?
The Federal Reserve’s independence is based on a historical agreement and legislative history, but it is also a response to negative outcomes when the line between monetary policy and politics has been crossed in the past. For example, in the 1970s, President Richard Nixon pressured the Fed to ease monetary policy in the run-up to his reelection, a move that contributed to spiking inflation that became entrenched. In another example that relates to the Trump administration, executive branch desires to address budget shortfalls through influencing central banks’ policies led to negative outcomes in Argentina and Germany. Research provides further support for Fed independence by providing data to back up the finding that independence of central banks is associated with financial stability.
The Fed’s primary tool for accomplishing its mandate is its ability to set the federal funds rate, which affects interest rates and, hence, the cost of borrowing throughout the economy. When the federal funds rate goes down, so do rates on mortgages, car loans, and credit cards, encouraging more spending in the economy—at least for a time. But it’s not that simple. There’s a lag in its effects, and keeping the federal funds rate too low or low for too long may heat up the economy too much, requiring the Fed to bring the rate back up. Drastic or sudden action on rates in either direction—or at the wrong time—can harm the economy, for example, by causing sustained high inflation or job losses, as expectations of high inflation become entrenched. Importantly, the federal funds rate is a blunt tool. The health of the economy is determined by complex and interactive factors, all of which the Fed must take into account and carefully weigh.
The health of the economy is determined by complex and interactive factors, all of which the Fed must take into account and carefully weigh.
So, while the Federal Reserve’s decisions may be criticized time and again from across the political spectrum, at the end of the day, most accept that the Fed must make monetary policy decisions as free as possible from political influences and based solely on its mandate of ensuring stable prices and maximum employment, rather than on service to the president. The list of those who agree is long and includes business leaders, investors, former Fed chairs, many scholars, think tanks, and policymakers of all stripes.
Conflicts of interest raise red flags that political interference could occur. Stephen Miran, now confirmed as a Fed governor, has refused to break his tie to the administration during his stint at the Fed, instead going on unpaid leave from his position as head of the White House Council of Economic Advisers. Experts and policymakers are concerned that he will be influenced by the political goals of the president in the future, especially given an essay he co-authored last year calling for reforms that would effectively provide paths for increased presidential control over the Fed.
Independently set rates are more predictable for businesses, investors, and consumers
The Federal Reserve is required to communicate why it makes the decisions it makes, how it might change the federal funds rate in the future based on likely economic scenarios, and what data it is relying on. As a result, economic experts often have a good idea before each FOMC meeting what the Fed is likely to decide.
Because of this transparency and stability, businesses can plan, knowing, for example, what their cost of borrowing is likely to be. Meanwhile, investors have the confidence to make longer-term investments, knowing that monetary policy is unlikely to change dramatically from one political election to another. And consumers can better plan when to purchase a home for which they will need a mortgage.
Political interference tends to upend this predictability and undermine incentives to invest and hire until the uncertainty passes.
With an independent Federal Reserve, the U.S. economy’s reputation is stronger and more attractive to foreign investment
The U.S. dollar has been the world’s primary reserve currency since the mid-20th century and is the most widely used currency in international trade. The Federal Reserve’s independence underpins the dollar’s status.
Politically expedient lowering of interest rates can lead to a weaker dollar and misallocation of money in the economy to unproductive firms. Importantly, investment experts warn that it can “undermine the credibility of the government on many levels, including government data, which affects investors’ ability to make long-run forecasts for corporate earnings, cash flows and valuations.”
Political interference tends to upend this predictability and undermine incentives to invest and hire until the uncertainty passes.
Knowing that the rates will be based on well-researched data, and not political whims, assures the world that the U.S. economy will remain relatively stable and its markets will remain rational—barring unexpected occurrences. Few foreign investors want to risk their money in a volatile, unpredictable environment.
It is no wonder that as President Donald Trump tries to take the unprecedented step of firing a Fed governor and sends other signals that he wants to control monetary policy, experts across the political spectrum are sounding the alarm.
While independent, the Federal Reserve is nevertheless held accountable to the public for its actions
The fact that the Federal Reserve is independent does not mean that it is not accountable to the public for the decisions it makes or that its monetary decisions are secret.
Even though the Fed is free to implement its goals without political interference, the goals themselves are set by Congress. And Congress has established how governors are selected and how long they serve, including that they may only be removed for cause—laws that the Trump administration appears willing to break, given its effort to fire Lisa Cook for reasons that now appear to lack evidence.
Second, the Fed has a significant burden when it comes to transparency and accountability. The Fed chair must appear before congressional committees in the House and Senate twice a year and must provide accompanying reports detailing how the Federal Reserve is conducting monetary policy and its assessment of the future of the economy.
The FOMC releases a statement after each of its meetings, followed by meeting minutes and, ultimately, full meeting transcripts as well as a public quarterly summary of committee participants’ forecasts of key economic variables. The Fed has provided even more detail in the past when responding to financial crises. This information, along with the Fed’s data and research analyses, are posted on the Fed’s website.
All of this communication helps provide Congress, as well as households and firms, clarity about what the Federal Reserve will aim for in the future under various economic conditions. And Congress is free to require more accountability if needed.
Read more
Conclusion
Determining where to set short-term interest rates is extremely complex and involves continuous gathering and analysis of the best data possible. What politicians want to see may or may not be consistent with what the data suggest. Either way, political motivations have no place in monetary policy.