LONDON, May 28 (Reuters Breakingviews) - If whoever wins the U.S. presidential election in November cares about stability and prosperity, they would do well to leave the independence of the Federal Reserve alone. A whispered plan from allies of Donald Trump to bring the central bank, and its Chair Jerome “Jay” Powell, to heel is both dangerous and impractical. Nonetheless, a wider discussion about the role of the Fed could be useful. The public has the right to ask for more scrutiny of a singularly powerful institution.
The Fed’s rapport with politicians has ebbed and flowed ever since its birth in 1913. In the words of former Chair William McChesney Martin, the central bank is “independent within the government, not independent of the government”. But that’s not good enough for some. Last month, the Wall Street Journal reported, opens new tab that unnamed officials in Trump’s first administration had drafted a document aimed at diluting the Fed’s independence during a possible second Trump term. Among their ideas: forcing the central bank to consult the president on interest rate decisions and allowing the White House to fire Powell before his term ends in 2026. The Trump campaign played down the plan but, if implemented, either of those proposals would represent the biggest political constraint on the Fed since Treasury secretaries stopped, opens new tab being part of its decision-making board in 1935.
There’s a practical obstacle: the Fed’s governance is enshrined, opens new tab in the Federal Reserve Act, changes to which require Congressional approval. Even assuming that can be obtained, though, subjecting the central bank’s key function – setting the price of money – to White House control would be disastrous for the economy. There is ample empirical evidence in favour of keeping politicians and their short-term whims at bay. A landmark study, opens new tab of 16 industrialised countries, including the United States, by Alberto Alesina and Lawrence Summers showed that between 1955 and 1988, those with independent central banks had both lower and less volatile inflation rates.
Perception matters too. Undermining the independence of the world’s most powerful monetary authority would unsettle financial markets – which use U.S. official rates as the key yardstick to price most assets – and threaten the dollar’s role as the global currency of choice. Kevin Warsh, a former Fed governor often cited as a potential Trump pick to head the institution, warned, opens new tab in 2010 that such costs would be “incalculable”, adding that “there is no such thing as being a little bit independent or a little bit credible”. As the mountain of outstanding U.S. government debt rises, trust in the U.S. financial system becomes only more important.
Firing Powell, meanwhile, looks like a tall order. The president nominates the Fed chair, who is then confirmed by the Senate – in fact, it was Trump who picked Powell in 2017. But the Federal Reserve Act says that the president can only remove Fed board members “for cause”, meaning for good reasons typically related to conduct or performance. Since there is no precedent, any attempt to defenestrate Powell for a Trump-picked alternative would almost certainly end up in the Supreme Court.
Hare-brained as the proposal from Trump’s associates is, the Fed-bashers do raise a debate that’s worth having: how to improve the way elected representatives and voters keep tabs on the central bank. That discussion isn’t really about interest rates, since the Fed already does a lot to explain its actions. Powell holds a press conference after every meeting of the rate-setting Federal Open Market Committee and testifies before Congress twice a year. Board members and senior officials at the 12 regional Feds speak several times a week. Fed-watchers can also feast on FOMC minutes, quarterly economic projections and a banquet of semiannual reports.
The Fed’s bond-buying is a different matter. Following the financial crisis in 2008 the central bank bought government bonds as a way of injecting cash into the economy in what’s known as “quantitative easing”, or QE. Its balance sheet ballooned to $9 trillion from less than $1 trillion and remains at around $7 trillion. As the Fed bought, it pushed long-term interest rates lower.
While Fed officials consider bond-buying to be a monetary policy tool, it also helps Washington pay less on its vast debts. As such, it bleeds into fiscal policy, which is the exclusive purview of the government. For that reason, it would make sense to give Congress more of a say. In Britain, where the Bank of England also engaged in QE, a parliamentary committee concluded, opens new tab that the practice “has blurred the lines between monetary and fiscal policies”.
The Fed’s role in regulating banks also deserves more transparency. Consider the embarrassing climbdown over new capital rules known as the Basel Endgame, proposed by Fed supervisory head Michael Barr last July, and which Powell says will now undergo “broad material changes” after vicious opposition from lobbyists, banks themselves and even progressive groups. Separately, Barr last week said regulators could ask large banks to hold more liquidity on their balance sheet to withstand unexpected runs on deposits.
Any such a move could increase costs for banks and their shareholders. But the Fed hasn’t yet proved that it can effectively enforce the rules it already has. The failure of Silicon Valley Bank last March revealed a panoply of cultural and procedural problems at the central bank, whose job it was to supervise and examine the ill-fated lender. Any decision by the Fed to prevent further failures, as it did by creating new lending facilities to banks in need of cash, could burden the public purse and the private sector.
Sure, the Government Accountability Office, the independent Congressional watchdog, audits, opens new tab the Fed regularly. But a more stringent oversight could come if the Fed’s non-monetary decisions were subjected to the same rigorous cost-benefit analysis by the Office of Management and Budget – a branch of the White House – as other government departments.
The risk is that in the name of preserving independence, the Fed is treated as untouchable, even where changes would be beneficial. Moreover, targeted reforms might make it less likely that rapacious politicians manage to storm the citadel of monetary policy. There was a time when a Fed chair like Alan Greenspan could pride themselves on “mumbling with great incoherence”. Whether Trump wins the election or not, those days are gone.
