Fed Independence – Why It Matters

The head of the US Federal Reserve Jerome Powell wears a purple tie.  This symbolic gesture is to indicate that he and his role in shaping monetary policy are not blue or red but instead are independent of partisan politics.  This independence is a critical principle and not just a trivial whim; history has proven that having an independent central bank is critical for a stable and robust economy.  And conversely, there are a list of examples from both distant and recent history about what happens when the policies of a central bank are instead influenced by the short-term agendas of politicians. 

Most of these examples come from other countries – places like Argentina, Turkey, and Zimbabwe have experienced periods of hyperinflation sometimes exceeding 100% or more, mainly due to (or at least exasperated by) a mismanagement of monetary policy by a central bank that was not given full independence.  These mind-boggling numbers in these relatively distant lands make it feel like it could never happen here, trapping us in a complacency that we are immune from such economic trouble.  But if you look at the decisions made in these countries, the rationales start to sound eerily similar to some of the arguments currently being made in this country.

For example, let’s look at the recent economic, political, and inflationary history in Turkey.  The country is currently led by Recep Erdogan, who has been President since 2014.  Although he was democratically elected, his regime has been marked by concerted efforts to move toward an authoritarian state by limiting the power of Parliament and other institutions including their central bank.  Without a strong and independent central bank, Erdogan has repeatedly flaunted traditional economic principles by pushing for lower federal interest rates even during periods of high inflation which has only sent inflation rates up even more.  A high interest rate of 12% in 2020 went to 20% in 2021 and up again to 72% in 2022, leading to an economic crisis which persists today with inflation still over 30%.  Conversely, during this same period, our independent central bank and its leader Jerome Powell were able to engineer a soft landing for our economy by raising interest rates to control inflation from a high of 9% during 2022 down to under 3% today, all while maintaining economic growth.

However, we don’t have to look very far back in our own history for a cautionary tale about Fed independence.  In the lead up to the 1972 presidential elections, Richard Nixon wanted his head of the Federal Reserve Arthur Burns to lower interest rates to stimulate economic growth.  We know this because there are now public tapes of the phone calls where Nixon would repeatedly attempt to influence, cajole and bully Burns into compliance.  Eventually, Nixon got his way – Burns lowered rates, economic growth was stimulated in the short term, and Nixon was re-elected.  However, inflation soon reared its head to levels that we had not seen in the previous century, leading to a gas and oil crisis and a decade of economic stagnation.

Fortunately, Jerome Powell has shown himself so far to be nothing like Arthur Burns.  If and when the Fed lowers interest rates, it will be because he believes it is in the best long-term interest of our economy.  However, Powell’s term runs out next spring if he doesn’t get pressured out before then, at which point Trump will nominate his successor.  We should all be paying attention as to whether that nominee will be more like Powell, or more like Burns.