The Battle for Economic Control: Trump vs. the Fed
A Clash of Interests
President-elect Donald Trump campaigned on a promise to reduce borrowing costs and lighten the financial burden on American households. However, many economists expect interest rates to remain elevated, well above pre-pandemic lows. This could lead to a clash between Trump and the Federal Reserve, particularly its chair, Jerome Powell.
The Importance of Independence
Powell emphasized the importance of the Fed’s independence, stating that it allows the central bank to make decisions for the benefit of all Americans, not for any particular political party or outcome. This independence is crucial in keeping inflation in check, as a central bank must often take unpopular steps to slow borrowing and spending.
A Recipe for High Inflation
Trump’s proposals to cut taxes and impose steep tariffs could lead to high inflation in an economy operating at close to full capacity. If inflation were to reaccelerate, the Fed would need to keep interest rates high, contradicting Trump’s promises of lower borrowing rates.
The Risk of Conflict
The risk of conflict between the Trump administration and the Fed is high, according to Olivier Blanchard, former top economist at the International Monetary Fund. If the Fed hikes rates, it could stand in the way of what the Trump administration wants. However, the Fed’s rate cuts might not reduce borrowing costs for consumers and businesses significantly, as longer-term interest rates are shaped by investors’ expectations of future inflation, economic growth, and interest rates.
The Limits of Fed Control
The Fed’s key short-term rate can influence rates for credit cards, small businesses, and some other loans, but it has no direct control over longer-term interest rates, such as mortgage rates. Rates on Treasury securities might rise to attract enough investors to buy the new debt, making it difficult for the Fed to control borrowing costs.
The Consequences of Conflict
Persistent attacks on the Fed could undermine its political independence, leading to higher inflation. If markets, economists, and business leaders no longer think the Fed is operating independently, they’ll lose confidence in the Fed’s ability to control inflation. This could lead to a self-fulfilling prophecy, where consumers and businesses anticipate higher inflation, fueling higher prices.
A Precedent for Disaster
History has shown that when presidents intrude on the Fed’s interest rate decisions, it can lead to stubbornly high inflation. The most egregious example is President Richard Nixon’s pressure on Fed Chair Arthur Burns in 1971, which contributed to the entrenched inflation of the 1970s and early 1980s.
A Global Perspective
Most advanced economies have independent central banks, but in some cases, governments have sought to dictate interest-rate policy, leading to soaring inflation. Turkey’s president, Recep Tayyip Erdogan, pressured the country’s central bank to cut interest rates, leading to inflation skyrocketing to 72% in 2022.
The Future of Economic Policy
As Trump prepares to take office, the battle for economic control between the administration and the Fed is likely to intensify. The outcome will depend on whether the Fed can maintain its independence and make decisions based on economic data, rather than political pressure.
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