By Robyn Bardmesser
The United States is ostensibly in solid macroeconomic health, stock markets continue to break records, unemployment is at a record low, and the recovery from the 2008 recession is now stretching into over a decade. There are still some reasons for concern, such as key manufacturing indexes dipping over the summer and a stubbornly depressed labor force participation rate. But overall, there seem to be few structural undercurrents that would justify pushing the federal funds rate, the main tool the Federal Reserve uses to steer the economy—which is typically employed as a countercyclical measure employed during, not before, a recession. Nothing, except for President Donald Trump, and his increasingly tempestuous relationship with Jerome Powell, the Chairman of the Federal Reserve.
President Trump has gone where presidents typically do not go—criticizing the macroeconomic decisions of the entire Federal Reserve system, typically in the form of tweets. For example, on Sept. 19, 2019, the president tweeted, “Jay Powell and the Federal Reserve Fail Again. No ‘guts,’ no sense, no vision! A terrible communicator!” Then, on Oct. 1, Trump struck a similar chord: “As I predicted, Jay Powell and the Federal Reserve have allowed the Dollar to get so strong, especially relative to ALL other currencies, that our manufacturers are being negatively affected. Fed Rate too high. They are their own worst enemies, they don’t have a clue. Pathetic!”
While we are accustomed to Twitter being a political tool within President Trump’s repertoire, the usage of Twitter to publicly shame Fed decisions and threaten to fire Powell harms what is seen as one of the fundamental pillars of monetary policy—central bank independence. By coercing Powell into lowering interest rates, President Trump is spurring a brief spurt of economic growth, just in time for the 2020 elections. This situation reinforces why central bank independence is crucial for monetary policy. Even though central bankers are often ineffective, if not outright destructive, and political intervention is sometimes warranted, autonomy is necessary for protecting monetary policy decisions from politicians. This is especially true for the United States, where the president has outsized power compared to leaders elsewhere in the world.
The practice of the independence of central banks is being challenged not just in the United States but also in Europe. Christine Lagarde, former head of the International Monetary Fund, was appointed to head the European Central Bank—with the EU at an existentially pivotal point in its history, in part due to monetary policy controversies in its last decade. In response to these controversies, central bankers from around Europe expressed reasons to be concerned for the independence of the ECB through a memorandum, published in October 2019. Specifically, they criticized the efforts to prevent a deflationary spiral—when an economy becomes trapped in a negative inflation environment—which has not been a risk since 2014. The authors also called out the lack of focus on price stability, coupled with an overly loose monetary policy. They argue that “like other central banks the ECB is threatened with the end of its control over the creation of money. These developments imply a high risk for central bank independence—de jure or de facto.”
Similar concerns are echoed in India as well. Over the summer, the deputy governor of India’s Reserve Bank of India, Viral Acharya, departed his position, constituting the third departure of voices dissenting the economic agenda of the Indian government within three years. The former governor, Urjit Patel, similarly left, and was replaced by a civil servant. By changing the key decision-makers to those who agree with the consistently fiscally irresponsible government in New Delhi, the government is creating a sycophantic central bank. This change in staff is concerning, firstly because the Reserve Bank of India has developed a new inflation-targeting agenda, in order to increase the usage of the Indian rupee abroad. The makeup of the new cabinet casts doubt on its ability to follow through with this new agenda. Furthermore, central bank independence is considered a feature of modern developed economies by investors, and by undermining this, the Indian government is jeopardizing its perception within international capital markets. This also echoes the concerns evoked with President Trump threatening to fire Powell.
As monetary policy has an inherently long-term vision, shielding it from political decisions that tend to be short-sighted is justified. Most central banks control the macroeconomy within their country (or economic region, in the case of the European Central Bank) primarily using interest rates. Interest rates control the extent of investment in the economy—lower interest rates spur investment and grow the economy, while higher interest rates work in the opposite way. The traditional monetary policy tool of central banks during a recession within developed countries is lowering interest rates.
However, interest rates in Europe and Japan are now negative, which is not only unhealthy for the financial industry but also renders the central banks less capable of dealing with a recession. This is because if rates fall too far below zero, the incentive to hold cash, effectively a zero-interest investment, grows. And once cash-hoarding gets going, monetary policy, which largely operates by influencing financial markets, begins to lose its bite. Great Britain is close to zero, and the United States is not far above that. The question then becomes—do the central bankers actually know what they’re doing?
This question can be similarly asked of Ben Bernanke, who was the Chairman of the Federal Reserve in the lead up the 2008 crash, when he was presented with much evidence of a housing bubble, which then led to the worst recession this world has seen since the Great Depression. Ben Bernanke is an academic by training, a similar background to many of those who work in the Federal Reserve, leading to accusations of the Fed exhibiting groupthink. That has led some to argue in favor of political oversight, to keep the economy from being solely managed by a like-minded cadre of academics. Nevertheless, independence of the Fed from politics is correctly seen as important, especially given that the head of the political system of the United States is President Trump, who is by no stretch of the imagination a scholar of economic theory.
Within the controversies with India, the EU, and the United States, it is easy to forget that central banks often fail, even as they are independent, and political intervention does not inherently constitute politicization. Central banks have failed before in their monetary policy decisions, even while independent, and sometimes removing that autonomy is not poisonous to economic growth.
Beginning in the 1990s, the Bank of Japan’s abrupt swings in monetary policy jeopardized the Japanese economy, leading to Prime Minister Shinzo Abe removing its de facto autonomy. In 1999, the BOJ adopted a zero-interest-rate policy in response to deflationary concerns, while simultaneously not expanding the money supply, a decision widely criticized as incoherent. Afterwards, it raised interest rates despite a decline in inflation, before reversing this decision seven months later. It then promised to increase the interest paid on reserves held at the BOJ, but instead reversed the policy in 2006, despite the lack of sustained recovery it had expected—just in time for the 2008 global recession.
When Shinzo Abe took office, he threatened to change policies governing the banks unless they complied with his economic agenda, and he appointed a governor that shared his views. As a result of monetary policies they ended up adopting, inflation finally picked up in the Japanese economy. Without removing the autonomy of the Bank of Japan, Abe would not have been able to effectively utilize it to revitalize the economy, and the Bank of Japan may have continued with its flip-flopping, ultimately destabilizing monetary policy and the entire economy.
The Fed’s central mandates of macroeconomic and financial stability, along with low inflation and maximum employment, require it to be in sync with politics, not just macroeconomic theory. Central bank independence rightly assumes that politicians will not know what they’re doing when they tinker with complex macroeconomic controls such as interest rates, or will be self-serving in the short-term but destructive in the long-term. But independence also simultaneously depends on central bankers knowing what they’re doing, which isn’t always the case. That said, central bank independence remains crucial for monetary policy, precisely because politicians like Abe are rare—and political regimes like Trump’s and Modi’s far less so.