Can politics and the Fed mix or is it oil and water?

Extensive academic research shows the importance of central bank independence in reducing inflation. Those institutions with strong operational independence from political figures have been more successful in keeping inflation expectations anchored and achieving lower inflation.

What you will learn:

• Risks of political interference in central banks’ decision-making and personnel appointments are rising globally and there is talk of this in the US, with speculation that another term by former President Donald Trump would include the president having greater input in monetary policy decisions. Separately, some Democrats are putting pressure on President Biden to lobby the Fed to start cutting interest rates. In either case, this is a slippery slope and potentially has adverse economic consequences, like the lessons learned under former Fed Chair Arthur Burns.
• To illustrate the potential economic implications, we adapted one of our Trump scenarios to incorporate assumptions about a less independent Fed. This modified scenario requires changes to the path of the fed funds rate, beginning in June 2026, shortly after when Powell’s term as chair ends, along with an upward adjustment to inflation expectations because of a dovish tilt by the central bank. Powell’s replacement would be appointed by Trump and confirmed by the Senate. The results show that realized inflation would be higher than in our initial Trump scenario and the baseline.
• The risk that the Fed loses significant independence is a tail risk. It will likely be difficult for the next president to revamp the Federal Reserve Board unless there is a wave of resignations among the governors, making the risk low that the Fed becomes swiftly less independent.