A global outcry has erupted as central bankers unite to defend the US Federal Reserve and its chairman, Jerome Powell, against unprecedented attacks from President Trump. This extraordinary show of unity is a stark reminder of the delicate balance between politics and economics, and the potential consequences of blurring those lines.
The stakes are high, and the world is watching.
Central bankers from diverse nations, including Australia, Brazil, Canada, Europe, New Zealand, South Africa, South Korea, and the UK, along with the Bank for International Settlements, have issued a joint statement of support for Powell. This is an unusual move, but these are indeed unusual times.
The reason for their collective action is simple: US interest rate decisions have global repercussions. Central bankers want to prevent a dangerous precedent from being set, one that could undermine the independence of central banks and their ability to make crucial economic decisions based on evidence and conditions, rather than political pressure.
Over the years, independent central banks have become the global norm, and for good reason. Allowing politicians, especially an unpredictable one like Trump, to dictate monetary policy is a recipe for disaster. It was this very independence that helped avoid a repeat of the sustained high inflation of the 1970s.
But here's where it gets controversial...
Trump has been waging a multi-year campaign against the Fed, expressing his desire to remove Powell before his term ends in May. He's also facing a criminal probe and a Supreme Court case over his attempts to remove another Fed board member, Lisa Cook. And this week, Powell revealed he's been served with a subpoena by the US Department of Justice, threatening a criminal indictment related to renovations at the Fed's historic office buildings.
Trump denies involvement, but Powell has released a strong statement in his defense, calling the investigation a pretext for a deeper issue: the independence of the Fed.
On Tuesday, over a dozen of the world's leading central bankers issued a statement of solidarity with the Fed and Powell, emphasizing the importance of central bank independence for price, financial, and economic stability. This sentiment was echoed by a group of leading US economists, including all the living past chairs of the Fed, who warned that undermining the Fed's independence could have highly negative consequences for inflation and the economy.
And this is the part most people miss...
Trump wants the Fed to lower interest rates dramatically, from the current target range of 3.5-3.75% down to 1%. Most economists believe this would lead to a large increase in inflation, which is already above the Fed's 2% target in the US. The Fed's interest rate would typically only drop to 1% during a serious recession.
History provides clear examples of the dangers of politicized central banks. The Fed's lowering of interest rates before the 1972 presidential election, attributed to pressure from President Nixon, contributed to the high inflation of the mid-1970s. More recently, Turkey's President Recep Tayyip Erdoğan's influence on the country's central bank to cut interest rates resulted in very high inflation, followed by very high interest rates to regain control.
Trump should be cautious about what he wishes for. If he succeeds in appointing a compliant Fed chair and board members who lower interest rates to 1%, expected and actual inflation will rise, leading to higher long-term interest rates. US voters may face greater affordability issues in the lead-up to the mid-term elections, potentially followed by a recession as interest rates rise to tackle inflation.
As global central bank leaders have warned, what happens in the US has worldwide implications. The world's economic stability hangs in the balance, and the outcome of this battle for central bank independence will be felt far and wide.
