As I write this column late on Monday afternoon, the major U.S. equity market averages (Dow Jones Industrials, S&P 500, and NASDAQ) are each off between two and three percent for the day, continuing a downward trend that has been going on since mid to late February. While much of the recent volatility in these markets have been blamed on uncertainty related to the Trump administration’s tariff policies (please see my April 9 column), additional uncertainty has been thrown into the mix, as President Trump has threatened the traditional independence of the Federal Reserve (hereafter identified as “the Fed”). President Trump began his attacks on Fed Chairman Jerome “Jay” Powell last Thursday, indicating in a social media post that Powell is always “TOO LATE AND WRONG” and insisting that Powell’s “termination cannot come fast enough!” President Trump is apparently upset that the Fed (the U.S.’s Central Bank) has not cut interest rates while Europe’s Central Bank has been cutting rates. President Trump escalated his attacks on Chairman Powell this morning, posting that the economy will slow unless Powell cuts interest rates immediately. While President Trump might be correct that rates should be cut (experts are divided), his attempt to influence the Fed and/or remove Powell is problematic.
Before we delve into the importance of the independence of the Fed, let us first examine the difference between fiscal policy and monetary policy. Fiscal policy refers to the tax and spending policies of a national government. In the United States, fiscal policy is determined by Congress and the Presidential administration. Monetary policy is managed by the actions of a central bank, which in the case of the United States is the Federal Reserve. The primary goals of the Federal Reserve are to make monetary policy decisions such that in the U.S., prices remain stable (i.e., low rates of inflation), employment remains high, and the economy grows at a stable rate. The main tool the Fed can exercise to maintain these goals is interest rates. The Fed primarily controls the “federal funds rate,” which is the interest rate at which banks lend reserves to each other overnight, but more importantly, influences other interest rates in the economy. Higher rates are typically used to temper inflation, as we have seen most recently, while lower rates are used to stimulate growth and employment. So, while the politicians in the White House and on Capitol Hill control fiscal policy, it is the Fed that independently controls monetary policy. Now, let us consider why the Fed’s independence is a good thing.
Independence means the Fed can set interest rates without interference from Congress or the Presidential administration. The reason this is so important is that politicians are usually in favor of lower interest rates because, in the short term, it makes their constituents happier. In the short term, lower interest rates result in higher economic growth and output, along with employment gains. However, in the longer term, this will typically lead to inflation. Politicians are more focused on the short term to enhance their popularity and potential future electability. As Austan Goolsbee, the current President of the Federal Reserve Bank of Chicago and voting member of the Federal Open Market Committee (the FOMC which sets rates), indicated this morning on CNBC, in countries which do not have an independent central bank, their inflation is higher, their unemployment is higher, and their economic growth is slower. An independent central bank, like the Fed, can be a steady hand, considering both the short-term and the long-term, and providing more certainty for financial markets.
This appears to be most critical right now, given the amount of uncertainty that has been generated by the Trump administration’s tariff policies. As President Trump indicates in his most recent social media posts promoting lower interest rates, recent data appears to show inflation under control. Energy costs and food costs are doing much better. However, the uncertainty of what will happen after the 90-day pause in “reciprocal” tariffs is causing the Fed to hesitate when it comes to lowering rates. If these reciprocal tariffs are reinstated, an inflationary environment is likely to follow. An independent Fed must not only consider the recent positive inflation data but also must be concerned about the future impact of current policies.
As a businessperson, investor, or even just as a participant in the U.S. economy, an independent Federal Reserve should enable you to sleep better at night. It is the role of the Fed to ensure that you have a job, that your earnings maintain their spending power, and that the economy continues to grow to improve your quality of life. While the members of the Fed may not always be perfect, their independence allows them to put the U.S. economy first above all else. In addition, its independence allows markets and businesses to be more confident. While facing so much uncertainty at this time, such a steady hand should be valued.
