Trump's Fed Interference: A Risky Gamble Threatening to Fuel Inflation

During his campaign last fall, former US President Donald Trump promised voters that he would quickly defeat inflation once back in the White House. However, his unprecedented and sustained attacks on the Federal Reserve (the Fed) may backfire.

Although Trump was the first US president to attempt to oust Fed governors, he is not the first politician to seek lower interest rates. Of course, presidents want to please voters with ultra-low interest rate mortgages, car loans, and credit cards. It's no wonder they want to see an economic boom to achieve stunning GDP growth and record stock prices, providing material for their campaign ads.

The core of the problem lies in the fact that the Fed's design to be independent of political interference is no joke. Economists and former Fed officials warn that Trump's interference in the Fed is like playing with fire. They point out that allowing the White House to direct interest rate decisions to please voters could backfire, and history has proven these fears.

"I'm concerned about this. It seems like another attempt by the president to undermine the independence of monetary policy, which will ultimately lead to worse economic consequences," Narayana Kocherlakota, former president of the Federal Reserve Bank of Minneapolis, said in a phone interview with CNN.

The Risk of Overheating the Economy

The main problem is that artificially lowering interest rates can overheat the economy, exacerbating inflation - which is exactly what Trump promised to solve. Low borrowing costs usually stimulate demand, regardless of whether the economy needs stimulus or not. Excessive stimulus can lead to too many dollars chasing too few goods, which is what caused inflation to soar to a 40-year high after the Covid-19 pandemic.

Current inflation is already worryingly high, and the Fed's efforts to achieve its 2% inflation target have stalled in recent months, partly due to Trump's historically high tariff policy. Voters are already fed up with high living costs, and intervention in the Fed could exacerbate this problem.

Mortgage Rates Could Skyrocket

Another major risk is that if investors suddenly become concerned about the Fed losing its independence and its determination to fight inflation, the market will panic. The key point is that the Fed's power stems in part from its ability to convince markets and the public to strictly control inflation.

If investors doubt the Fed's commitment to keeping inflation low, they will obviously demand higher returns to hold long-term bonds. In other words, long-term interest rates, which are controlled by investors rather than the Fed, will rise, and long-term interest rates are directly linked to mortgage rates.

"The more the market thinks the White House is directing Fed policy, the higher long-term interest rates, such as mortgage rates, will be," said Kocherlakota, who worked at the Fed until 2015 and is now a finance professor at the University of Rochester. Mortgage rates are already frustratingly high, hovering around 7% for most of the year, exacerbating the housing affordability crisis and making the American dream out of reach for too many.

This is precisely the ironic aspect of Trump's attack on the Fed: he may undermine his campaign promise to lower inflation, while at the same time exacerbating the number one economic problem - the cost of living.

Historical Lessons from Nixon and Erdogan

History shows that intervention in central banks can end tragically. In 1970, then-President Richard Nixon appointed his chief economic aide Arthur Burns as chairman of the Fed. Although Burns was known for his fight against inflation, historians say Nixon succeeded in pressuring this confidant to stimulate the economy with low interest rates to boost political capital.

According to an article published in the Journal of Economic Perspectives in 2006, a review of telephone conversations "clearly shows that President Nixon directly and indirectly pressured Burns... to implement an expansionary monetary policy before the 1972 election." "Nixon demanded that Burns provide an expansionary monetary policy and economic growth before the 1972 election." By the end of the 1970s, prices were completely out of control. In 1980, inflation soared to over 13%, and unemployment skyrocketed, triggering a crisis later known as "the Great Stagflation".

In recent years, Turkish President Recep Tayyip Erdogan fired the central bank governor in 2021 and appointed a confidant. As the Turkish central bank cut interest rates at Erdogan's direction, the Turkish lira plummeted and inflation soared to over 80%.

"History has already told us what happens when populist strongmen decide to take over central banks," Justin Wolfers, an economist at the University of Michigan, said in a phone interview with CNN.

Tim Mahedy, former senior advisor to the Federal Reserve Bank of San Francisco, described Trump's attempt to oust Governor Lisa Cook as a "blatant attack on the Fed's independence." Mahedy, the current CEO and chief economist at Access/Macro, said in an email to CNN that Trump has "politicized monetary policy to some extent".

"Trump is breaking the fundamental rule of central banking: you can criticize, but don't politicize," Mahedy said. "If his pressure efforts succeed, we will all pay a heavy price - a price that will be borne by future generations."