Sliding Off the Fence: The Divide Over Fed Rates
Undermining the autonomy of central banks yields economic consequences, asserts Goldman Sachs.
In a candid chat on The Claman Countdown, former NEC Director Lael Brainard breaks down the high-stakes game of rate cuts.
Recently, Goldman Sachs economists delved into the risks that come with interfering with the autonomy of central banks in setting monetary policy. Their findings paint a concerning picture, revealing potential consequences such as increased inflation, plummeting stock prices and a deteriorating currency.
Studies examining the independence of central banks worldwide, led by Jan Hatzius and team at Goldman Sachs, conclude that more politically independent central banks are more adept at striking a balance between maintaining a low and stable price level while keeping the economy near full employment.
Pointing to dangers that threaten the Fed's independence, the report singles out public political pressure as a significant risk. This pressure, they argue, could erode the public's perception of the U.S. monetary policy's independence. Other threats include alterations in regulations empowering the removal of Federal Reserve officials and concerted efforts to force the ousting of Fed Chair Jerome Powell or other officials, despite recent statements backing down from such threats.
The report arrives as President Donald Trump continues to voice his disapproval of Powell's policies, repeatedly urging for interest rate reductions. He has gone so far as to endorse potential dismissals of Powell, though he has since claimed he has no intention of making such a move. Questions remain about Trump's legal authority to make such a decision.
The Fuse Fizzles Out: Trump Removes Powell from the Firing Line
Trump's criticism of Powell has been prevalent during his presidency, with the president frequently arguing that interest rates are being set too high and too late. These harsh words have stirred up market turmoil, contributing to a notable market rout in the face of broader uncertainty over trade policy.
In April, Trump expressed his frustration with Powell in a social media post, stating that "Powell's termination cannot come fast enough." He has dubbed Powell a "FOOL," "a major loser" and even advocated for "preemptive cuts" to the interest rates. Later on, Trump pulled back on his threat to dismiss Powell, telling reporters that he had "no intention of firing him." Following the Fed's decision to hold rates steady for a third straight meeting in May, Trump took to social media once more, labeling Powell as a "FOOL, who doesn't have a clue."
The President's Power Play
The Federal Reserve is entrusted with the responsibility of upholding a dual mandate: ensuring maximum employment and maintaining stable prices.
Under the current legislative framework, the Fed chair can only be dismissed "for cause." Powell himself has affirmed in press conferences that political removal is not permissible under the law. This protection also extends to the governors of the regional Federal Reserve banks. However, there are uncertainties regarding how ongoing court cases involving other independent federal agencies may impact the central bank's independence.
Studies suggest that institutional alterations that boost central bank independence—including the appointment and removal process—can reduce inflation by half to one percentage point in subsequent years[2][3][5]. Pending legal cases could potentially threaten the Fed's independence and, in turn, drive up inflation.
The Cost of Lose Federal Reserve Independence
Historically, unscheduled leadership changes at global central banks have been associated with a one percentage point increase in inflation following the leader's ouster[4]. More recently, Trump's comments on Powell’s future have created market turbulence. Financial conditions tightened, equity valuations weakened, and the U.S. dollar depreciated when Trump raised the prospect of removing Powell on April 18, but these effects reversed following Trump's retreat from his threats on April 22.
The Goldman Sachs analysis highlights that most institutional changes to monetary policy in advanced economies have moved in the direction of greater independence, whereas significant shifts towards reduced independence have predominantly occurred in emerging markets. Nevertheless, the data indicates a strong link between the Fed's independence and economic stability. A weakening of the Fed's autonomy, as inferred by Trump's rhetoric, could potentially trigger upward inflationary pressure, stock price declines, and a depreciation of the U.S. dollar.
- The ongoing debate about interest rate cuts, as discussed by Lael Brainard on The Claman Countdown, has implications for the economy, potentially leading to increases in inflation and losses in the stock market.
- Studies on the independence of central banks worldwide, led by Goldman Sachs economists, indicate that more politically independent central banks are better able to balance maintaining a low and stable price level with keeping the economy near full employment.
- The report from Goldman Sachs warns of dangers to the Federal Reserve's independence, highlighting public political pressure and threats posed by changes in regulations and attempted removal of Federal Reserve officials, including Jerome Powell, as significant risks.
- President Donald Trump's criticism of Jerome Powell's policies and frequent calls for interest rate reductions have stirred market turmoil and contributed to market routs, especially in the face of broader uncertainty over trade policy.
- The analysis by Goldman Sachs suggests that weakening the Federal Reserve's autonomy, as inferred by Trump's rhetoric, could potentially lead to upward inflationary pressure, declines in stock prices, and a depreciation of the U.S. dollar, similar to what has been observed in emerging markets undergoing reduced central bank independence.
