As Trump rails against Fed Chair Powell, here’s why Federal Reserve independence is essential

If you aren’t following the drama featuring President Donald Trump and Federal Reserve Chair Jerome Powell, you might want to tune in. Not for its spectacle — it’s quite dispiriting — but because how it plays out has big implications for the economy.

It’s not a misreading to say Trump is upset with Powell. He wants the Fed to cut interest rates significantly and quickly. However, Powell and other Fed members have another view, and want to keep rates where they are, at least for now. This disagreement is so distressing to the president that he has openly considered firing Powell.

It’s unclear whether the president has the legal grounds to dismiss the Fed chair, and he has since said he does not have an intention to do so, but all the sturm und drang calls into question the Fed’s independence.

Congress established the Federal Reserve as an independent government agency more than a century ago. It was not created under the president’s purview, though some of its members, like the Fed chair, are presidentially-nominated and Senate-confirmed.

The Fed sets short-term interest rates based on what its members think is appropriate to ensure low and stable inflation and a full-employment economy — the Fed’s so-called dual mandate. It is critical that the Fed’s interest rate decisions are made without political consideration.

The Fed has done its job admirably over the decades.

Before the Fed’s founding, the economy was continually roiled by financial crises and recessions. Sure, the stock market remains highly volatile, and there are still bank runs and economic downturns, but thanks to the Fed’s stewardship, they are nowhere near as frequent or as severe. The Fed doesn’t always get it right, but it does so much more often than not.

The Fed has also been largely successful in maintaining its independence. The only glaring exception was when Richard Nixon was president and appointed his friend Arthur Burns as Fed chair. To help stoke the economy and sway the 1972 election, the Burns-led Fed ignored the incipient inflation of the time and kept interest rates down. Nixon handily won the election, but inflation took off, resulting in deep recessions in the ensuing decade.

This is also the consistent history lesson from across the globe: When a country’s central bank takes its direction from those in power, it invariably keeps interest rates too low for too long to pump up the economy to help the incumbent stay in power. However, the low rates ultimately ignite higher inflation, ending in recession, often years later.

Trump has since disavowed plans to fire Powell, noting that his term as chair ends in May, but global investors’ reaction to Trump even contemplating it is telling.

On cue, short-term rates fell, as investors anticipated that the next Fed chair, who will take the reins in May if Powell completes his term, will be more dovish. Trump wants lower rates, and investors believe odds are whoever he appoints will oblige.

But while short-term rates, which the Fed largely controls, fell, long-term rates rose. That’s because investors in long-term bonds rightly worry that a Fed working to keep short-term rates inordinately low will lead to higher inflation. There’s nothing more lethal to the returns of an investment in a long-term bond than inflation, and thus to compensate for the expected inflation, investors require a higher interest rate.

Thus, by keeping short-term rates inappropriately low, the Fed could cause long-term rates to rise.

That’s a big problem if you want a mortgage to purchase a home, as the rate on a 30-year fixed-rate mortgage is tied to long-term Treasury rates, and current mortgage rates are already unaffordable for most American families. Higher long-term Treasury rates also mean higher rates for home equity and auto loans.

Higher long-term rates are also a financial headache for many businesses, as they borrow long-term money to finance their big investment projects and hiring. Think about billions of dollars in extra interest payments on the massive loans needed to build all the data centers powering artificial intelligence.

We also got a sneak peek of what would happen to the value of the U.S. dollar if the Fed’s independence is questioned: It would fall.

Higher U.S. tariffs and a global trade war are already good reasons for international investors to worry about whether the U.S. is a safe place to invest. They will be even more alarmed if they must fret that the Fed might set interest rates based on what the president wants and not what the U.S. economy needs.

Powell and the Fed could be wrong this time, and aggressively cutting rates might be just what the economy needs. I doubt it, but that’s beside the point. An independent Fed is an essential ingredient in the secret sauce that has made the U.S. economy the world’s biggest and strongest.

Without independence, the Fed would not be able to do its job, and the future of the U.S. economy would be badly diminished.

Mark Zandi is the senior economist for Moody’s Analytics.