President Trump has taken several swipes at the Federal Reserve in recent months. In October, he slammed the Fed’s decision to continue gradually raising interest rates in the context of what he has described as the “Best Economy & Jobs EVER.” He doubled down on this position in November, as the stock market sunk even further.
“I think the Fed is making a mistake,” Trump told the press corps. “They’re so tight. I think the Fed has gone crazy.” In a later interview with Fox News, he reiterated his disappointment. “The Fed is going loco and there’s no reason for them to do it. I’m not happy about it.” And just last week, in an interview with the Wall Street Journal, he said, “I think the Fed right now is a much bigger problem than China. I think it’s — I think it’s incorrect what they’re doing. I don’t like what they’re doing.… they’re not being accommodative at all.”
By openly criticizing the Fed, President Trump broke an unwritten rule of monetary policy. But he is by no means the first sitting president to undermine the Fed’s independence.
The late economic historian Allan Meltzer made a career out of documenting the complicated relationship between the Fed and the federal government over the past century. His research makes it clear that, despite recent protestations to the contrary, the Fed has never been independent of politics.
Any notion that the Fed would be independent was shattered within its first few years of existence. During World War I, Congress strong-armed the newly created Fed into buying bonds to help finance the war effort. The Fed’s willingness to accommodate the debt triggered our highest inflation rates since the Revolutionary War.
During the Great Depression, FDR repeatedly lobbied Congress to grant him greater authority over monetary policy as part of his controversial campaign to devalue the dollar and move toward a managed currency. Executive Order 6102 made it illegal for the public to hold gold coin, bullion, or notes. The Gold Standard Act of 1934 officially devalued the dollar from $21 an ounce to $35.
The Fed again accommodated wartime deficits during and after World War II, buying up billions of dollars in government bonds to peg interest rates. By 1951, Fed independence had been so compromised by the Treasury that the two sides agreed to return control over monetary policy to the Fed.
Despite the passing of the Treasury-Fed Accord, political tinkering with the Fed accelerated during the 1960s and 1970s. The Kennedy, Johnson, and Nixon administrations each pressed the Fed to help finance the deficits that resulted from the Vietnam War and Great Society programs. In his 1967 State of the Union Address, Johnson vowed to “do everything in the President’s power to lower interest rates and to ease money.” And Nixon, on the day of Arthur Burns’ appointment as Fed chair in 1970, made an open appeal: “Dr. Burns, please give us more money!”
In light of the sudden collapse of the gold standard under Nixon and this overt politicization of monetary policy, it’s no shock that the 1970s saw inflation soar to double digits and unemployment remain high for much of the decade. As Meltzer noted, “political concerns weakened whatever independence the Federal Reserve had just at the time when an independent central bank was most needed.”
It wasn’t until Paul Volcker’s tenure under the Carter and Reagan administrations that the Fed was able to achieve any sort of autonomy from politics. The results of the Great Moderation speak for themselves. Unfortunately, the moderation came to a crashing halt in 2009, when Chair Ben Bernanke and Treasury Secretary Hank Paulson worked together to ram through controversial bank bailouts. As Meltzer concluded, “under Mr. Bernanke, the Fed has sacrificed its independence and become the monetary arm of the Treasury.”
The Fed is not independent, and it never has been. But it could be. The path forward is simple. The Fed should adopt a strict rule for monetary policy. By binding its hands, the Fed would leave no doubt that the drama of politics won’t play a role in its decisions.
The 115th Congress considered mandating the Fed adopt an explicit rule. But the legislation failed to gain sufficient support. However, as Marc Labonte notes in a Congressional Research Services report, such a mandate seems to be unnecessary: “Under current law, if the Fed desired, it could arguably adopt these proposals voluntarily (e.g., the FOMC [Federal Open Market Committee] could agree to base their vote on a Taylor rule’s prescription).” It can and it should.
Politics can be exciting. Monetary policy should be boring. Central banks perform better when they are independent from politics. The Fed could bolster its independence by adopting a monetary rule. With President Trump calling out Fed officials in the press, there has never been a better time to do so.