Interest Rate Cuts and Federal Reserve Independence

Recently, President Trump has been vocally urging Federal Reserve Chairman Jerome Powell to slash interest rates, igniting a firestorm of concern regarding the independence of the Federal Reserve. Such worries are not unfounded; history teaches us that the more autonomous a central bank is from political influence, the healthier a nation’s economy tends to be when evaluated through metrics like inflation. For those keen on delving deeper, a comprehensive survey of the relevant literature can be found here. The Banking Act of 1935 was pivotal in restructuring the Federal Reserve to enhance its independence from both the Executive branch and Congress.

To be fair, Trump is not the sole figure attempting to curtail the Fed’s independence. Libertarian-minded advocates also champion reduced autonomy for the Fed, often rallying with slogans like “Audit the Fed!”

But just how much sway does a sitting president exert over Federal Reserve monetary policy? The short answer is: probably not as much as one might think.

Monetary policy is orchestrated by the Federal Open Market Committee (FOMC), comprising 12 members: the seven members of the Fed’s Board of Governors, the president of the New York Federal Reserve Bank, and four rotating presidents from other Federal Reserve Banks. Among these, only the Board of Governors is appointed by the President (and subsequently confirmed by the Senate) for staggered 14-year terms. Currently, of the sitting members (Jerome Powell, Philip Jefferson, Michelle Bowman, Michael Barr, Lisa Cook, Adriana Kugler, Christopher Waller), only one—Adriana Kugler—has a term that expires during Trump’s current administration. Although Powell’s tenure as chairman is limited, he remains on the board until his full term concludes. Hence, Trump could only appoint one member to this 12-person committee, and even if this individual were to be a compliant puppet, one vote is hardly enough to sway the majority. Including the three members he appointed during his first term only brings his influence to four out of twelve.

Now, you might be scratching your head, wondering, “How did Trump appoint three members in his first term given these 14-year stints?” The answer lies in the fact that not all Fed governors serve their entire terms. This elite cadre of finance professionals often opts for jobs elsewhere, finding those 14 years a daunting commitment that entails significant opportunity costs.

To entertain a hypothetical scenario: imagine all seven board members resigning before their terms conclude, and a president successfully appoints (and secures confirmation for) seven new members who all adhere to his monetary whims. In this extraordinarily unlikely case, it might be possible for the president to steer monetary policy in a particular direction.

However, as Jason Furman, former head of the Council of Economic Advisers under Obama and current Harvard professor, points out, the Federal Reserve is not a central planner in the traditional sense:

President Trump’s focus on a Fed Chair who will slash rates is misguided even on his own terms:

1. The Fed Chair is just one of 12 votes; a politically manipulative Chair won’t command a majority.

2. Even if the Federal Funds Rate were reduced, factors like higher expected inflation could drive up mortgage rates.

The Federal Reserve only sets a limited number of interest rates, specifically those that govern interbank lending—the discount rate (the rate at which banks can borrow from the Fed) and the interest rate paid on bank reserves held at the Fed. While the Fed seeks to influence the Federal Funds Rate (the rate at which banks lend to one another) through its operations, it does not unilaterally set that rate.

The interest rates that you and I encounter—like those for mortgages and credit cards—are determined by market dynamics: risk, inflation, supply, demand, and so forth. The Fed cannot directly dictate these consumer rates. It endeavors to influence them, but it does not wield that power outright.

Therefore, even if a president could somehow exert complete control over monetary policy, it is unlikely that such actions would yield the desired results. If Federal Reserve interest rates are lowered without justification, commercial banks will likely anticipate higher inflation, ultimately leading to increased nominal interest rates for consumers. Should a president react to this predictable outcome with threats of price controls or other “solutions,” it could exacerbate an already problematic situation.

In conclusion, while concerns about Federal Reserve independence are valid, it would require a series of extraordinary missteps for that independence to be significantly compromised.