As the Federal Reserve becomes more aligned with the executive branch, its traditional mandate to control inflation independently weakens. Consequently, voters may start holding the incumbent political party directly responsible for rising prices, making inflation a key electoral issue rather than a purely monetary one.
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The appointment of Kevin Warsh as Fed Chair shifts the focus from purely economic decisions to a fundamental governance question: will the central bank remain independent or take political orders from the president? This represents a potential paradigm shift in the separation of powers.
Rajan suggests that a central bank's reluctance to aggressively fight inflation may stem from a fear of being blamed for a potential recession. In a politically charged environment, the institutional risk of becoming the 'fall guy' can subtly influence policy, leading to a more dovish stance than economic data alone would suggest.
The Fed's recent rate cuts, despite strong economic indicators, are seen as a capitulation to political pressure. This suggests the central bank is now functioning as a "political utility" to manage government debt, marking a victory for political influence over its traditional independence.
Increasing political influence, including presidential pressure and politically-aligned board appointments, is compromising the Federal Reserve's independence. This suggests future monetary policy may be more dovish than economic data warrants, as the Fed is pushed to prioritize short-term growth ahead of elections.
Central bank independence is a relatively new concept from the 1990s. Historically, central banks operated as junior partners to the government, executing industrial policy. The move to subordinate the Fed to the Treasury is a return to a long-standing historical model.
Ongoing political pressure, including attempts to remove a governor and uncertainty over the next Fed Chair, is perceived as a threat to the Federal Reserve's independence. This political risk is a key factor leading to the view that inflation break-evens are too low and their risks are skewed to the upside.
While the direct impact of tariffs may be temporary, the elongated process risks making consumers and businesses comfortable with higher inflation. Combined with questions about the Federal Reserve's political independence, this could unmoor expectations and make inflation persistent.
The debate over Fed independence is misplaced; it has already been compromised. Evidence includes preemptive reappointments of regional bank presidents and outspokenness from governors concerned about being bullied, indicating the Fed no longer operates in its prior insulated environment.
The Federal Reserve's independence is crucial for long-term economic stability because it prevents presidents from succumbing to the political temptation of lowering interest rates for short-term popularity, a move that risks spiraling inflation.
Despite the perception of independence, the Federal Reserve historically yields to political pressure from the White House. Every US president, regardless of party, has ultimately obtained the monetary policy they desired, a pattern that has held true since the Fed's creation.
