This tendency, if left unchecked, could severely harm a country’s long-term economic health. Keeping interest rates unnaturally low for a prolonged period tends to produce inflation, which could result in a recession or destroy an economy altogether. Mexico’s economy, for example, suffered from high inflation and low growth in the 1970s and early 1980s as anxious incumbent presidents pushed for expansionary fiscal and monetary policies culminating in crises in 1976, 1982 and 1995 — all election years or immediately following one.
These facts have led virtually every developed economy to provide for a central bank’s political independence. Those who run the bank, such as the chair and governors of the United States’ Federal Reserve Bank, are appointed to serve fixed terms during which they cannot be removed by politicians. This, plus a global culture among central bankers that jealously preserves their independence, means that central banks can make decisions about managing the economy without fear of losing their jobs.
This system is far from ideal. Central banks suffer from all the problems endemic to any central planning authority. Despite all of the information their staffs generate, Fed governors will never have enough information to know everything relevant to an economy’s health. They are human beings, which means they suffer from the same confirmation bias and resistance to changing their intellectual paradigms that hinder any other person. But the alternatives are either no central lending authority at all, which creates the risk of unbridled financial panics during liquidity crunches, or political control of monetary decisions. Both are much worse than our imperfect — but functioning — system.
Trump’s efforts to cajole the Fed into lowering interest rates is, as noted, not unusual even in this age. Richard M. Nixon blamed Dwight Eisenhower’s refusal to push for fiscal and monetary stimulus for his narrow 1960 loss to John F. Kennedy. When Nixon became president, he appointed his friend, Arthur Burns, as Fed chair, who willingly complied with Nixon’s request for fiscal stimulus going into his own 1972 reelection bid. Ronald Reagan is known for backing Fed Chair Paul Volcker’s high interest rate policy early in his term to crush inflation, but that didn’t stop him from having his chief of staff pressure Volcker to not raise interest rates going into his 1984 campaign. Trump’s tweets and efforts to appoint loyalists such as Stephen Moore and Herman Cain to the Fed Board simply follow this history.
But no president so far has formally tried to interfere with the Fed’s independence. Were Trump to fire or demote Powell, as he suggested earlier this week, he would be crossing a very important line that separates the United States and other large economies from the more stagnant and politically hobbled economies elsewhere. It would be a challenge that cannot be left unmet.
Congress would have an opportunity to act if Trump were to try to remove Powell as chair and replace him with someone more to his liking. Though that effort would surely be challenged in the courts, it is unclear whether such a challenge would succeed. Chairs are confirmed by the Senate and serve a four-year term, but the relevant statute allows presidents to remove Fed governors “for cause,” and presumably, any effort by Trump would revolve around an interpretation of those words and their applicability to a governor’s status as chair. Court challenges always take time to resolve, and the resultant uncertainty over who will run the world’s most important central bank would surely destabilize the global economy. That gives Congress an incentive to act with uncharacteristic speed.
In such an event, Congress should immediately draft and pass legislation clarifying what “for cause” means and stipulating whether that language applies to a governor’s tenure as chair. Such legislation should define “cause” narrowly to encompass only a felony or severe misconduct on behalf of the affected governor. It should also provide for an expedited court process to determine the validity of a president’s attempt to remove a governor for cause. Finally, it should either provide that the chair cannot be removed for cause or establish that the incumbent chair retains his or her office until Congress confirms that person’s successor. These provisions should ensure the independence of the Fed and its chair.
Eliminating arbitrary political control over the nation’s money supply is a great advance in modern economics. Regardless of what one thinks about the course the Fed ought to take, preserving that advance should be a national priority if and when the Fed’s independence comes under assault.