Ask the expert: Political pressure on the Fed has reached a climax

The Federal Reserve was intended by the Constitution’s framers to be insulated from political pressures and changing administrations, and board governors serve a single 14-year term. Now, President Donald Trump’s disapproval of Federal Reserve Chair Jerome Powell has led to the Department of Justice launching a criminal investigation into Powell, placing the institution into the political spotlight.

Recently, Trump announced Kevin Warsh as his nominee to replace Powell, whose term ends in May. While U.S. presidents have long criticized the Federal Reserve’s economic decisions, there are concerns about the central bank’s independence and what pressures Trump could apply to ensure Warsh follows his lead.

Cristina Bodea is a professor in the Department of Political Science at Michigan State University’s College of Social Science where she studies central bank independence and monetary policy. Here, Bodea explains why independence matters, how political interference can backfire and the implications for the economy.

Responses and excerpts are from an article published in The Conversation.

How unique is this moment in American history?

It is unique in the sense that we have not seen a Federal Reserve chair criminally investigated.

That said, if we go back to the Nixon and Reagan years, presidents have put a lot of pressure on chairs when economic conditions were bad, more precisely, when both unemployment and inflation were high. In more recent history, Fed chairs and the U.S. Federal Reserve have enjoyed bipartisan support in being independent.

Why are central banks independent and what is at stake?

Independence comes in two forms: legal and in practice.

Legal independence means the law governing the institution allows experts to look at economic data and make interest rate decisions based on their mandate, such as low inflation, without politicians interfering in day-to-day operations. This does not mean the Fed is not accountable. It is accountable to Congress, and Fed leaders are appointed by the president and confirmed by the Senate.

There is also de facto independence. Because laws are debatable, what happens in practice can differ from what is written.

Over the past 30 years, the Federal Reserve has been more independent than the law alone suggests. There was a clear bipartisan consensus to avoid politicizing the institution so it could safeguard price stability and employment without regard to elections or who is in the White House.

Why might politicians interfere with a central bank?

Monetary policy is a powerful tool that can have large and quick effects. Politicians may want to use it for short-term gains, such as cheaper credit and somewhat higher employment.

But it’s a double-edged sword. Politicians cannot fool people repeatedly. If people expect monetary policy to be misused, that leads to inflation and expectations of inflation. Employment only increases if inflation expectations are stable.

Putting pressure on the Fed from the current administration has been an attempt to take over the institution. A central bank that is not a credible inflation fighter cannot stabilize employment either.

Is this kind of threat against a central bank’s independence a global issue?

This is not uniquely American. It has happened in countries like Turkey, Venezuela and Argentina. Globally, central bank independence has been under attack, but this is not typical of major democracies or countries that claim to have strong institutions and the rule of law.