Federal Reserve Independence Under Pressure: Politics and Power Play

The recent appointment of Stephen Miran, a new Federal Reserve governor influenced by President Trump, is raising concerns about the future of U.S. monetary policy. Miran, who holds views that diverge from the Fed's mainstream, is advocating for sharp interest rate cuts despite concerns about persistent inflationary pressures.

Miran has already voted against the Federal Open Market Committee's (FOMC) decision to lower the benchmark interest rate by 25 basis points, arguing for a larger cut of 50 basis points. He has also called for further cuts in 2025, which would bring the federal funds rate target range down to 2.75% to 3%. This contrasts with the Fed's own forecasts, where most estimates anticipate inflation rising to 2.6% next year, with risks tilted to the upside.

Despite declaring his independence, Miran remains chairman of the White House Council of Economic Advisers on leave and is scheduled to end his term on the Fed in January. Furthermore, he has previously called for a closer link between the Federal Reserve system and political will.

Other Threats to Fed Independence

The threat to the Fed's independence is not limited to appointments like Miran's, but extends to Congress, specifically the Senate, which is responsible for approving these appointments. The question is: how much control is the Senate willing to give the President over the Fed?

The Federal Reserve's mandate, which aims to "stabilize prices and achieve full employment," is a democratically agreed-upon mission defined by law. The Fed must prove to Congress that it can achieve these goals and explain to the public how it balances them when there is a conflict, while maintaining its role as a fair arbiter of financial stability.

One of the key challenges for the Fed is explaining how it can mitigate the larger risks that could pass through to households without supporting financial markets and institutions, especially after the high inflation experience in 2022. Despite these challenges, the Fed still enjoys high credibility, with long-term inflation expectations remaining stable near the 2% target.

Congress' Declining Role

Congress has shown "neglect" of the Federal Reserve in many ways, including its role in the runaway inflation of 2021-2022. For example, the Consumer Price Index (CPI) rose to 9.1% in 2022, its highest level in four decades. Although multiple factors contributed to this increase, such as supply chain bottlenecks and massive fiscal stimulus, inflation signals were clear by mid-to-late 2021, especially with accelerating service prices.

However, the Fed did not begin raising interest rates until March 2022, when the annual inflation rate rose to 7%. Some analysts believe that part of the responsibility lies with the new political framework adopted by the Fed in 2020, which was "biased towards inflation." This in-depth analysis could have been the basis for Congress to conduct a review or form a neutral investigation committee.

In conclusion, the Federal Reserve faces difficult decisions in the future, and avoiding negative political reactions requires more dialogue with Congress. Maintaining the Fed's independence requires greater transparency, linking each Fed official's interest rate expectations to their economic outlook, focusing on unemployment, inflation, and GDP.