Monetary Policy

It’s probably safe to say that almost no one following the news believes that Donald Trump has a solid, defensible reason to fire Federal Reserve Board Governor Lisa Cook, as he purported to do Monday, notwithstanding his assertion that she is guilty of “potentially criminal conduct.”

It’s not only that the charge she falsified information on mortgage applications is unproven, or that even on their face the accusations are thinner than onion-skin paper.

It’s that Trump has telegraphed his true objective loud and clear virtually from the inception of his current term: to destroy the Fed’s independence so he can force it to act in accordance with what he sees as his immediate political advantage, chiefly by cutting interest rates at a time when that would be economically irrational.

He has pursued this objective in several ways. He has consistently denigrated the work of Fed Chairman Jerome Powell, questioning why Powell was ever appointed (and forgetting that he was the president who appointed Powell).

He has carried on about the cost of a renovation of the Fed’s Washington headquarters building, even misrepresenting the cost and nature of the project, suggesting that it points to Powell’s managerial ineptitude.

And now he’s trying to fire Cook, one of Powell’s supporters on the Fed board. Whether he can do so in the face of Cook’s refusal to go is unclear, and likely to be judged on by the Supreme Court.

That leads us to the principle of Federal Reserve independence and its critical importance for the health of the U.S. economy.

The Fed isn’t the only central bank that cherishes its independence. Most central banks in developed countries do too, although they solidified their status at different times — the Bank of England gaining operational independence over monetary policy in Britain only in 1997.

To be fair, the character of central bank independence has always been murky. “Central banks do not and should not operate in a vacuum,” Tobias Adrian and Ashraf Khan of the International Monetary Fund observed in 2019, acknowledging that “as public institutions, central banks should be held properly accountable to lawmakers and to society.”

Indeed, to paraphrase Finley Peter Dunne’s Mr. Dooley, throughout its own history the Fed, like the Supreme Court, has “followed the election returns.”

That is, it’s rare for the central bank to range too far from what the public expects from government economic management. In any event, the Fed is a creation of Congress, which could theoretically expand or narrow its monetary policy authority and structure its board to make it more responsive to partisan politics.

The consensus among economists is that doing so would be unwise. Political leaders who have made their central banks subservient to their own policies have almost invariably learned the consequences the hard way, as economists across the economic spectrum observe.

“If a legislature or executive can order the central bank to print money,” wrote Thomas L. Hogan of the conservative American Institute for Economic Research in 2020, “then the government can spend without limit …which can lead to hyperinflation and economic disaster as seen in countries such as Zimbabwe, Venezuela, and Argentina.”

That’s a lesson that economists began urging on Trump as he stepped up his attacks on the Fed. “No one’s claiming that central bankers are going to be perfect at their jobs,” Peter Conti-Brown of the Wharton School said recently. “What we’re saying is that they’re going to be better than the alternative. The alternative is setting interest rate policy from the Oval Office, according to the whims of whatever the president wants to see that day. That’s the main alternative to central banking. And that’s what’s under threat today.”

The United States also learned the value of an independent Fed the hard way. For more than three decades after its creation in 1913, the Fed was largely a handmaiden of the U.S. Treasury; the Treasury secretary and comptroller of the currency were ex officio members of its board, and the Treasury secretary presided over its meetings.

That version of the Fed proved unequal to managing macroeconomic policy as the Great Depression deepened. It had few powers with which to set policy, especially with Franklin Roosevelt taking the reins of economic policy in his own hands.

FDR unilaterally took the U.S. off the gold standard in 1933. He would set the price of gold every morning with aides at his bedside, prompting the British economic sage John Maynard Keynes to complain directly to Roosevelt that “the recent gyrations of the dollar” looked to him “like a gold standard on the booze.”

Roosevelt eventually gave up on manipulating the price of gold and consequently the value of the dollar. He also recognized that the nation needed a firmer, professional hand on the monetary faucet. The solution came from the progressive-minded Utah banker Marriner Eccles, whom FDR tasked with remaking the Fed.

Eccles is almost entirely unknown to the public, but he’s revered among economic policy wonks — which explains why his name is on the Fed headquarters building. After FDR appointed him to head the Federal Reserve Board, Eccles oversaw the drafting of the Banking Act of 1935, which centralized monetary policy in the Fed board and gave it new powers to manage the money supply. Eccles remained the board’s chairman until 1948 and remained a board member until 1951.

Despite those reforms, however, the Fed remained tied to political imperatives, chiefly the financing of America’s fiscal needs during World War II, policies firmly under the control of the Treasury. “We are not masters in our own house,” one Fed bank governor lamented.

That began to change in 1950, when the process of paying for war expenses had triggered an inflationary spiral. The consumer price index rose by 17.6% in 1946-47 and another 9.5% the following fiscal year, thanks in part by the end of wartime price controls and the “pegging” of long-term treasury bond rates at 2.5%.

The onset of the Korean War in 1950 threatened more inflation. President Truman insisted on leaving the peg at 2.5% in order to limit the cost of government spending on the new war. Eccles and others on the Fed board feared, however, that keeping the rate from rising above 2.5% would require the Fed to keep buying T-bonds, which pumped more dollars into the money supply and fueled inflation. The Fed wanted to allow rates to rise, which was anathema to the White House.

This concern placed the Fed in open conflict with Truman and his Treasury secretary, his crony John Wesley Snyder. The Fed and Snyder engaged in increasingly acrimonious meetings, after one of which the White House issued a communique that falsely stated that the Fed had agreed to follow the administration’s demands. The Fed then issued its own statement, directly contradicting Truman’s.

Truman maintained publicly that keeping rates low was crucial for the fight against communism. “I hope the Board will … not allow the bottom to drop from under our securities,” Truman said, referring to the decline of treasury prices if the board let rates rise. “If that happens, that is exactly what Mr. Stalin wants.” Eccles, for his part, told Congress that if the Fed were forced to maintain the 2.5% peg, that would make the Fed itself “an engine of inflation.”

The war of words continued, until Assistant Treasury Secretary William McChesney Martin took over negotiations with the Fed from Snyder, who was recovering from surgery. Martin broke the logjam. The result was the Treasury-Fed Accord of March 4, 1951, a landmark document in Federal Reserve history. The accord gave the Fed full rein to manage short-term interest rates in return for its keeping long-term rates within the peg until the end of that year.

Truman appointed Martin as Fed chairman a few weeks later; some saw the appointment as a Treasury takeover, but Martin proved to be a firm advocate of Fed independence. The accord, as explained by Robert L. Hetzel of the Richmond Fed and Ralph Leach, who personally witnessed the 1951 negotiations, “marked the start of the modern Federal Reserve System” and established the central bank’s “dual mandate” of promoting stable prices and maximizing employment.

That doesn’t mean that the Fed rigorously honored its hard-won independence. Fed Chairman Arthur Burns acceded to Richard Nixon’s urging to keep rates low in advance of the 1972 presidential election. It was a disastrous misstep. Inflation soared, especially during the Arab oil embargo, peaking at nearly 15% in 1980.

It fell to Paul Volcker, who became chairman in 1979, to use the Fed’s authority to slay the inflationary beast. Volcker drove the Fed’s key rate nearly to 20%, provoking a recession and a sharp rise in unemployment. But the inflation rate fell back to 3.8% by 1983 and as low as 1.1% in 1986. Volckeer’s actions arguably set the stage for Ronald Reagan’s defeat of Jimmy Carter in 1980, but arguably he could not have taken the stringent measures needed to bring inflation down if he bowed to Carter’s electoral needs.

Former Fed Chair Ben Bernanke set forth the perils of political influence on the Fed in 2020, warning that central banks subjected to political pressure might “overstimulate the economy to achieve short-term … gains.” Those may be “popular at first, and thus helpful in an election campaign, but they are not sustainable and soon evaporate, leaving behind only inflationary pressures that worsen the economy’s longer-term prospects.”

That’s the prospect facing the U.S. as Trump keeps trying to erode the Fed’s independence, insisting on a rate cut no matter the overall economic environment. As it happens, he may get the rate cut he desires, but only because his tariff and immigration policies are sapping America’s economic strength, producing a slump that warrants a reduction.

Where will we go from here? Powell’s term as Fed chair expires next May. He has been admirably protective of the bank’s independence while in office, but it’s a safe bet that his Trump-appointed successor won’t be so solicitous. Harder times for the Fed, and the economy, may lurk over the horizon.

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Leading European stock markets reflected a cautiously positive sentiment on Friday as investors watched for progress on Ukraine peace talks and awaited a speech from US Federal Reserve chair Jerome Powell. He will speak on Friday at Jackson Hole, where central bankers gather for their annual meeting. 

Markets also digested details of an EU-US trade truce and better-than-expected business activity data, announced on Thursday.

Despite the news that the German economy shrank more than initially estimated in the second quarter, the German DAX changed direction and made up its earlier losses, gaining around 0.1% after 11.00 CEST.

The FTSE 100, though trading in negative territory all morning, also followed suit and changed course, gaining a few points by late morning.

The Paris CAC 40 was up 0.2%, the Madrid IBEX 35 rose by 0.4%, and the European benchmark STOXX 600 increased by 0.2%. 

As for the London blue chip index, the early morning slight dip appeared to be just a small correction. “The FTSE 100 saw a subdued start on Friday after achieving a record close above 9,300 yesterday,” said AJ Bell investment analyst Dan Coatsworth in his note.

Investors are focusing on the message Federal Reserve chair Jerome Powell might deliver at the Jackson Hole summit in Wyoming.

“Investors had been expecting a rate cut from the Fed next month so if Powell were to say anything suggesting rates might be kept on hold, it could see stocks come under greater pressure,” said Coatsworth. He added that robust PMI data from the US on Thursday pointed to a strong economy, potentially reducing the chances of the Fed lowering borrowing costs.

A cut in interest rates would be the first of the year and it would give asset prices and the economy a boost — but it could also risk worsening inflation.

The Fed has been hesitant to cut interest rates this year out of fear that President Donald Trump’s tariffs could push inflation higher, but a surprisingly weak report on employment growth earlier this month suddenly shifted focus towards the job market. Trump, meanwhile, has forcefully pushed for cuts to interest rates, directing fierce criticism towards Powell.

US markets closed in a gloomy mood

On Wall Street on Thursday, the S&P 500 slipped 0.4% to 6,370.17, continuing a gradual decline since a record on 14 August. The Dow Jones Industrial Average dropped 0.3% to 44,875.50, and the Nasdaq composite fell 0.3% to 21,100.31.

In other dealings early on Friday, the US dollar rose to 148.48 Japanese yen, from 148.37 yen. The euro slipped to $1.1590 from $1.1606.

Meanwhile, oil prices fell by midday in Europe; the US benchmark crude lost 0.2% and was traded at $63.38 per barrel. Brent crude, the international standard, also was down by 0.2% at $67.52 per barrel.

Oil prices moved higher yesterday, “as the initial enthusiasm over progress towards a ceasefire between Russia and Ukraine continues to fade”, said ING in a note. Expectations of increased global uncertainty are driven by the difficulties of setting up a Putin-Zelensky summit and securing potential security guarantees for Ukraine.

Asian markets were also mixed on Friday

Asian shares were also mixed on Friday. In Tokyo, the Nikkei 225 rose less than 0.1% to 42,633.29 after Japan’s core inflation rate slowed to 3.1% in July, from 3.3% in June.

ING Economics said in a note that price pressures were broadly in line with market consensus. Inflation staying above 3% raises the likelihood of a rate hike as soon as October, it said.

In Chinese markets, Hong Kong’s Hang Seng index rose 0.9% to 25,339.14. The Shanghai composite index climbed 1.5% to 3,825.76.

South Korea’s Kospi added 0.9% to 3,168.73. Australia’s S&P/ASX 200 fell 0.6% to 8,967.40 as traders sold to lock in gains after the benchmark surged to record highs in recent trading sessions.

President Trump is once again floating the idea of firing Federal Reserve Chair Jerome Powell, ostensibly in objection to excessively high interest rates. But this debate is not about monetary policy. It’s a power play aimed at subordinating America’s central bank to the fiscal needs of the executive branch and Congress. In other words, we have a textbook case of “fiscal dominance” on our hands — and that always ends poorly.

I’m no cheerleader for Powell. During the COVID-19 pandemic, he enthusiastically backed every stimulus package, regardless of size or purpose, as if these involved no trade-offs. Where were the calls for “Fed independence” then? And where were the calls for fiscal restraint after the emergency was over?

Powell failed to anticipate the worst inflation in four decades and repeated for far too long the absurd claim that it was “transitory” even as mounting evidence showed otherwise. He blamed supply-side disruptions long after ports had reopened and goods were moving.

And as inflation was taking a stubborn hold, Powell delayed raising interest rates — possibly to shield the Biden administration from the fiscal fallout of the debt it was piling on — well past the point when monetary tightening was needed.

If this weren’t the world of government, where failure can be rewarded — and if there had been a more obvious alternative — Powell wouldn’t have been invited back for another term. But he was. And so Trump’s pressure campaign to prematurely end Powell’s tenure is dangerous.

I get why with budget deficits exploding and debt-service costs surging, the president wants lower interest rates. That would make the cost of his own fiscal agenda appear more tolerable. Trump likely believes he’s justified because he believes that his tax cuts and deregulation are about to spur huge economic growth.

To be sure, some growth will result, though the effects of deregulation will take a while to arrive. But gains could be swamped by the negative consequences of Trump’s tariffs and erratic tariff threats. No matter what, the new growth won’t lead to enough new tax revenue to escape the need for the government to borrow more. And the more the government borrows, the more intense the pressure on interest rates.

One thing is for sure: The pressure Trump and his people are exerting on the Fed is a push for fiscal dominance. The executive branch wants to use the central bank as a tool to accommodate the government’s frenzy of reckless borrowing. Such political control of a central bank is a hallmark of failed monetary systems in weak institutional settings. History shows where that always leads: to inflation, economic stagnation and financial instability.

So far, Powell is resisting cutting rates, hence the barrage of insults and threat of firing. But now is not the right time to play with fire. Bond yields surged last year as investors reckoned with the scale of U.S. borrowing. They crossed the 5% threshold again recently. Moody’s even stripped the government of its prized AAA credit rating. Lower interest rates from the Fed — especially if seen as the result of raw political pressure — could further diminish the allure of U.S. Treasuries.

While the Fed can temporally influence interest rates, especially in the short run, it cannot override long-term fears of inflation, economic sluggishness and political manipulation of monetary policy driven by unsustainable fiscal policy. That’s where confidence matters, and confidence is eroding.

This is why markets are demanding a premium for funds loaned to a government that is now $36 trillion in debt and shows no intention of slowing down. But it could get worse. If the average interest rate on U.S. debt climbs from 3.3% to 5%, interest payments alone could soar from $900 billion to $2 trillion annually. That would make debt service by far the single largest item in the federal budget — more than Medicare, Social Security, the military or any other program readers care about. And because much of this debt rolls over quickly, higher rates hit fast.

At the end of the day, the bigger problem isn’t Powell’s monetary policy. It’s the federal government’s spending addiction. Trump’s call to replace Powell with someone who will cut rates ignores the real math. Lower short-term interest rates will do only so much if looser monetary policy is perceived as a means of masking reckless budget deficits. That would make higher inflation a certainty, not merely a possibility. It might not arrive before the next election, but it will inevitably arrive.

There is still time to avoid this cliff. Trump is right to worry about surging debt costs, but he’s targeting a symptom. The solution isn’t to fire Powell — it’s to cure the underlying disease, which is excessive government spending.

Veronique de Rugy is a senior research fellow at the Mercatus Center at George Mason University. This article was produced in collaboration with Creators Syndicate.

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The European Central Bank (ECB) has cut its deposit rate for the fourth time this year, by 25 basis points to 3%.

This is the rate for banks to make overnight deposits and also serves as the main tool for the ECB to steer the monetary policy stance.

The step was widely anticipated by the market, with further cuts on the horizon in 2025.

The ECB’s two other interest rates were lowered too, new interest rates have been set at 3.15% for main refinancing operations (for banks that borrow funds from the ECB on a weekly basis) and 3.4% for the marginal lending facility (overnight credit to banks against broad collateral).

As inflation nears the ECB’s 2% target, there is more focus on the Eurozone’s ongoing weak growth. The bloc is expected to grow 0.8% this year and 1.3% next year, according to forecasts from the European Union’s executive commission.

The ECB started cutting the main interest rates in June 2024 to boost the Eurozone’s lagging economy, through lower rates to encourage borrowing, extra spending and added investment.

After the widely anticipated cut, all eyes are on ECB President Christine Lagarde’s press conference on Thursday afternoon, as new risks have emerged since the bank’s last meeting on 17 October, including the political turmoil in the Eurozone’s two strongest economies and the results of the US election.

Investors are watching signs of what rate the ECB is eyeing to stop the cuts and also what inflation and economic projections the central bank is looking at to shape its monetary policy in 2025.