The Fed’s Independence Is America’s Armor

U.S. President Donald Trump’s unprecedented assaults on the Federal Reserve’s institutional autonomy – demanding the resignation of Fed Governor Lisa Cook, constantly deriding Chair Jerome Powell and threatening the bedrock principle of central bank independence. Trump’s recent firing of Cook over unsubstantiated mortgage-fraud accusations – and her immediate legal fight – has become a major flashpoint in a broader power struggle with far-reaching consequences for monetary credibility and economic stability.

In fact, the beat of Washington DC is often characterised by swathes of politicians, often even presidents, attacking the country’s central bank. That the current White House is articulating a blunt campaign to coerce the Federal Reserve into certain results is certainly not an isolated event in the history of central banking, but the manner in which it is being done is reminiscent of no other comparable period in modern history.

As much as it highlights the undying conflict between political expediency and sound economic policy, the implications of persistently attacking one of the world’s most important independent financial institutions could mark a turning point for years to come.

Congress’ Deliberate Design

It would be tempting to trace the Fed’s independence to the infamous 1951 Treasury-Fed Accord, when the Fed, under the guidance of U.S. President Harry Truman, declared publicly its entitlement to control the amount of money in circulation without being dictated by the Treasury. This story is interesting but incomplete. The bedrock of the Federal Reserve’s independence traces deeper, to the Banking Act of 1935.

Lawmakers acted with remarkable foresight in refusing to accept the vision of Marriner Eccles, the Governor of the Federal Reserve Board at the time, of direct presidential control of monetary policymaking. Eccles was a close associate to President Roosevelt and believed that an administration that handled the economic and social ills of the nation required a responsive relationship with the monetary system.

However, Congress, having long debated it, intentionally ordered institutional fortifications against such presidential influence: to provide terms of office (to board members) of 14 years, staggered, and to provide that the office could be removed only by reason (‘for cause’) – similar to the Supreme Court. The 1951 Accord was not in turn the formation of independence, but a dramatic assertion of the statutory independence that Congress had already inculcated a decade and a half earlier.

The Unyielding Logic of Independence

Right off the bat, the central bank independence argument is not an ivory tower abstraction. It is constructed of cold hard empirical data: countries with independent central banks always demonstrate better macroeconomic performance.

Take the case of the great U.S. inflation episode of the 1970s when the consumer price index (CPI) – a key measure of inflation – shot to a peak of almost 15% by 1980. This very dramatic moonshot reminds us of the consequences that befall whole economies when the temptation of short-term political interest, such as lowering interest rates to finance the state debt or stimulating a pre-election atmosphere, takes precedence over the long-term needs of price stability.

Financial markets, ever-watchful, are likely to react by de-anchoring inflation expectations, a disastrous development to all concerned – including the economic goals of the administration itself. It is the strategic equivalent of a corporate board that enables immediate stock price issues to side-track long-term R&D investment.

In fact, political independence is the core of any central bank’s credibility and global standing, its so-called ‘social contract’ with the people. It was interesting to note that long-term inflation expectations were anchored remarkably during the recent pandemic despite an unprecedented level of inflation. Why? The general population, either correctly or incorrectly, thought the Fed would eventually intervene to put the level of inflation back to 2%.

This faith, like brand equity, is incredibly difficult to develop and shockingly easy to squander.

Inflation over Growth

But what then happens when presidents lean on the Fed? A careful deconstruction of decades’-worth President-Fed interactions by University of Maryland macroeconomist Thomas Drechsel offers a sobering response.

His conclusion, based on rich archival evidence, is that political pressure to relax monetary policy, although able to reduce interest rates, does not produce positive impacts on real economic activity. Rather, it vigorously and incessantly raises the price level. Drechsel, quantitatively, calculates that political pressure even half as intense as Nixon’s in the great inflation episode, over six months, could increase the U.S. price level by some 7% over the next decade. That is a grim ‘stagflationary’ trend – rising prices, no actual output improvement.

It is not just Nixon; Drechsel demonstrates that it was such pressure that led to the inflationary periods under Presidents Johnson, Ford and Carter as well.

Perhaps most importantly, the transmission of political pressure ‘shocks’ is not the same as that of typical monetary policy easing: it is significantly more effective in influencing inflation expectations. Once President-Fed interactions become public affairs, private agents mostly respond by baking in future inflation to expectations. It’s an archetype of market signaling: once the game is perceived to be rigged, players change their strategies, usually to their collective detriment.

Reinforcing Trust

A central bank’s independence is not absolute, though. It requires accountability and transparency in a democratic society. The Andersen Institute makes a wise proposal of three specific actions that the Fed may undertake to strengthen this social contract:

• Enhancing communication: Dropping the often misunderstood “dot plot”, the anonymous map of individual Fed officials’ interest rate assessments. Rather, releasing more data on policymaker assumptions, especially on fiscal and trade policies, and describing the monetary policy reaction to diverse economic situations could be more useful. This would invite investors to value the various outcomes more correctly and push policymaking to be disciplined, fact-based, and, ideally, nonpartisan.
  
  
• Explain Balance Sheet Policy: The Fed’s balance sheet is a monumental beast with over $6.5 trillion in assets. Investors need a clearer understanding of the relationship between its size and composition and the level of both short- and long-term interest rates. Explaining conditions of Treasury purchases and future sales plans would de-mystify an important policy tool.
  
  
• Establishing Financial Stability Goals: The Fed has become more and more of a lender of last resort, implicitly guiding even institutions in which it does not have direct responsibilities. It should be of utmost importance to be clear about the principles that should inform such interventions, the means used and how to avert moral hazard, such as investors in stablecoins implicitly relying on the support of central banks. This is about the setting of limits of intervention, key to avoiding undue risk-taking.

For business executives, the study of this never-ending debate presents a poignant study of governance, risk handling and strategic communication under political pressure. The autonomy of the Fed is a national asset, a barrier to the whims of short-term politics that history has proven to cause long-term economic instability. Not only is its defense a good policy; it is an essential part of a stable operating environment.

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Recommended reading:

Drechsel, Thomas. 2025. Political Pressure on the Fed. University of Maryland, NBER & CEPR. July 30. http://econweb.umd.edu/~drechsel/research.html

Richardson, Gary, and David Wilcox. 2025. “How Congress Designed the Federal Reserve to Be Independent of Presidential Control.” Journal of Economic Perspectives 39 (3): 221–238. https://doi.org/10.1257/jep.20251447