Advisers to presidential candidate Donald Trump have reportedly circulated plans to put the Federal Reserve more under the president's control.
Economists say the Fed's independence and public trust in it are important to the central bank's ability to curb inflation.
In the past and in other countries, political control of central banks has led to higher inflation.
Political leaders often want to lower interest rates, which would benefit the economy in the short term, but this could lead to higher inflation in the future.
Who should control America’s money supply: experts, or elected representatives?
The long-running debate over who should run the U.S. central bank flared up again last month after The Wall Street Journal reported that members of Trump’s inner circle had discussed several proposals to put the Fed, which plays a key role in running the economy, more under the president’s control.
Economists say giving the president control of Fed policy would almost certainly lead to higher inflation. Most presidents would likely pressure the Fed to keep its benchmark interest rate lower than normal, fueling inflation.
“The evidence is very clear that if you abandon independent central banks, you will end up with higher and more volatile inflation,” said James Bullard, a former president of the Federal Reserve Bank of St. Louis who served on the Fed’s policy committee from 2008 to 2023.
Sarah Binder, a Georgetown University political science professor and an expert on how politicians influence the Fed, pointed to the era of “stagflation” as a cautionary tale. She said the double-digit inflation and economic stagnation of the 1970s were due in part to pressure from Presidents Lyndon Johnson and Richard Nixon on the Fed to lower interest rates.
“The record going back to the 1970s shows that this kind of political pressure fueled inflation for more than a decade,” she told Investopedia. “It’s not a foregone conclusion that the Fed will bend to Trump’s will, but it certainly puts the Fed in a particularly precarious political position.”
Independence of the Federal Reserve
The Federal Reserve is an unusual part of the U.S. government in that it is designed to be at least somewhat independent of the influence of politicians.
The Fed was created in 1913 to stabilize the financial system after a wave of bank failures, and its powers have grown over the years. It now regulates banks and, most importantly, sets the nation’s monetary policy.
In 1977, Congress gave the Fed a dual mandate — to control inflation while keeping the economy at full employment. It does this primarily by manipulating the federal funds rate, which determines the interest rate at which the nation’s banks lend to each other. This affects the interest rates on a variety of other loans throughout the economy, including business and personal loans (such as mortgages).
Decisions to raise and lower interest rates are made by a committee comprised of a rotating group of presidential appointees who serve 14-year terms and regional bank presidents who serve one-year terms.
Because the president can appoint only a handful of FOMC members during any given term, the committee has greater latitude than other federal agencies to operate as technocrats and make decisions based on what they believe to be wise economic policy, rather than political considerations—at least in theory.
Critics of the Fed have long sought to bring the central bank more under the control of other parts of the government. They often argue that the public cannot hold the Fed accountable because of its independence, making its governance undemocratic. Critics also call the Fed's economists unelected bureaucrats who they say should not be allowed to make economic policy decisions.
Why More Politics Leads to Higher Inflation
The Fed has been in the spotlight over the past few years as it has steadily raised the federal funds rate to curb inflation that has been running well above the central bank’s 2% target. The benchmark rate range is currently at a 23-year high of 5.25%-5.50%, the highest level since July.
Tight monetary policy helps lower inflation, giving consumers and investors hope that rate cuts may be around the corner. However, Fed officials have said they need to be more confident that price pressures are in check before easing policy.
Economists warned the Fed that its response to the president was more likely to allow inflation to run rampant.
Victor Lee, an economics professor at Villanova University, said presidents have good reason to pressure the Fed to lower interest rates and have done so in the past, in part because election cycles force them into short-term thinking.
When the Federal Reserve sets interest rates super low, loans become cheaper, people borrow more money to buy more things, companies hire more workers, and the economy booms — all of which are great things for presidents to do during their terms.
“Low interest rates may temporarily lead to lower unemployment, which looks great for incumbents running for reelection,” Lee said in an email.
But then comes the inevitable aftermath—businesses discover that their customers are wealthier and can pay more, so they raise their prices. Worse, because inflation is partly a psychological phenomenon, economists have found that popular beliefs about inflation can become a self-fulfilling prophecy.
"Inflation is a lagging indicator," Li said. "But when it arrives, when inflation expectations become unanchored, it can easily get out of control and turn into hyperinflation. This is the lesson of history, and if it is not understood, it is destined to repeat itself."
Lee and other economists point to the example of Richard Nixon, who leaned on Federal Reserve Chairman Arthur Burns to keep interest rates low before the 1972 election. Even though Burns was a respected economist who should have known better, he did so anyway, helping to spark the double-digit inflation the country experienced in the 1970s.
How affected should the Fed be?
To be sure, the Fed is not actually entirely divorced from politics.
As Georgetown University’s Binder and researcher Mark Spindell document in their book, “The Myth of Independence: How Congress Governs the Federal Reserve,” Fed officials did consider how their actions would be received by politicians, the public and financial markets. Those concerns appeared in the minutes of the Federal Open Market Committee and were released to the public five years later.
Fed officials must answer to lawmakers, who frequently push them in public hearings to move interest rates one way or another. Yet even as Congress has reorganized the Fed over the years, it has left the final word on monetary policy to the Federal Open Market Committee.
“If it comes down to it, Congress can do whatever it wants on monetary policy, so in that sense it is political," said James Bullard, former president of the Federal Reserve Bank of St. Louis. “But Congress has been looking at this for the last 100 years and has decided to keep some distance from the day-to-day politics.”
The Fed’s ability to shape inflation derives largely from the public’s belief that it will keep inflation at its 2% long-term goal. That could be jeopardized if the president overtly keeps his thumb on the scale.
“The challenge facing the Fed is its credibility and legitimacy,” Binder said. “It all stems from the public’s trust that the Fed knows what it is doing and will do it in a methodical manner. It will not simply twist in the wind and be buffeted by competing political parties or competing ideologies.”
Binder also worries that the Fed might overreact in the opposite direction, keeping interest rates too high in an effort to defend its credibility, thereby unnecessarily hurting the economy through monetary tightening.
Cautionary tales from around the world
Ian Sheperdson, chief economist at Pantheon Macroeconomics, points to the example of Britain, where the central bank was under the control of an elected government until 1997. That year, the Bank of England’s governance structure was changed to make it more independent. Not coincidentally, British inflation, long several percentage points higher than in the U.S. and Germany, was in line with other economies that year.
A 2022 study of 17 Latin American countries by the International Monetary Fund, a United Nations financial institution, found that countries with greater central bank independence had consistently lower inflation rates.
Turkey provides another striking example of the link between politics and inflation. Authoritarian ruler Tayyip Erdogan tried an unorthodox economic theory: lowering interest rates would reduce inflation. Instead, inflation reached 85.5% in 2023 before the central bank began using more traditional methods and raised rates.
Ultimately, the decision to change the Fed's structure will be up to Congress, and Bullard said based on his conversations with lawmakers, he sees little chance of that actually happening.
“Even if you think those people might be more extreme, both on the left and the right, they are very supportive in ordinary conversation,” Bullard said. “I don’t get the sense that they are seriously considering fundamentally changing the structure of the Fed.”
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