Global central bankers convened at a U.S. mountain resort this weekend are increasingly worried that the political turmoil surrounding the Federal Reserve could soon affect them as well.
Efforts by U.S. President Donald Trump to mold the Fed according to his preferences and push for interest rate cuts have sparked concerns about the Fed’s ability to maintain its independence and its reputation for controlling inflation.
Frustrated by the legal protections for the Fed’s leadership and the extended terms of its Board of Governors, Trump has been exerting significant pressure on Chair Jerome Powell to step down and is attempting to remove another board member, Governor Lisa Cook.
If the world’s most influential central bank succumbs to this pressure, or if Trump discovers a method to remove its members, it could set a dangerous precedent for Europe and Japan, where the independence of monetary policy could face new challenges from local politicians.
“The attacks on the Fed motivated by politics have implications globally, including in Europe,” said Olli Rehn, a European Central Bank policymaker from Finland, during the Fed’s annual symposium in Jackson Hole, Wyoming.
This is why Rehn and his colleagues are strongly supporting Powell to maintain his stance, even after he hinted at a potential rate cut in September. Powell received a standing ovation when he addressed the conference.
‘Not to be taken for granted’
Discussions with a dozen central bankers worldwide during the Fed’s retreat near the Grand Teton Mountains revealed that the possibility of the Fed’s independence being compromised, thus threatening its ability to combat inflation, is seen as a direct threat to their own authority and broader economic stability.
This scenario could lead to significant turmoil in financial markets, with investors demanding higher premiums for holding U.S. bonds and reevaluating the status of Treasury securities as the cornerstone of the global financial system.
Central banks globally are already preparing for potential repercussions, advising lenders to be cautious about their U.S. currency exposure.
More fundamentally, a loss of Fed independence would dismantle a regime of relative price stability that has been in place since former Chair Paul Volcker tackled high inflation 40 years ago.
Since then, an increasing number of central banks have adopted the Fed’s model of political independence and a singular focus on their mandate—primarily maintaining inflation around 2%.
“It serves as a reminder that independence cannot be taken for granted,” said Bundesbank President Joachim Nagel, also a member of the ECB’s Governing Council. “We must fulfill our mandate and demonstrate that independence is essential for price stability.”
Political football
So far, markets have not shown significant concern about the Fed’s independence. U.S. equity markets remain strong, and there hasn’t been a significant rise in Treasury yields or inflation expectations to suggest a risk to the Fed’s credibility.
While Trump can appoint a new chair when Powell’s term ends in May, he would need more vacancies among the Fed’s seven-member board to gain majority control. Additionally, the Fed’s network of 12 regional reserve banks, with leaders appointed by local boards, acts as a counterbalance to Washington’s influence.
Nonetheless, Trump’s contentious relationship with the Fed, in a nation known for strong institutional and legal traditions, has heightened awareness among other central bankers of the fragility of their own independence.
Even the ECB, whose autonomy from the euro zone’s 20 governments is protected by EU treaties, has had to vigorously defend its independence.
It faced accusations of financing governments when it initiated a large bond-buying program a decade ago to prevent deflation, surviving multiple legal challenges.
In countries like Italy, Germany, and France, both right- and left-wing parties have periodically criticized their central bank.
In other nations, appointing a national governor has become a political issue.
Latvian central bank governor Martins Kazaks faced criticism from national politicians for not aligning with government wishes during his contentious reappointment process. Slovenia has been without a governor since January due to political disputes.
In Japan, former Prime Minister Shinzo Abe criticized central bank governor Masaaki Shirakawa for insufficient action against deflation, appointing Haruhiko Kuroda in 2013 to lead after Shirakawa resigned weeks prior to his term ending.
Kuroda launched an extensive asset-buying program, which helped devalue the yen and stimulate growth, but drew scrutiny from traditional central bankers as the BOJ became the primary creditor of its own government.
Setting a bad example
Trump remarked that Powell’s term ending next May “can’t come soon enough” and has publicly initiated the search for a successor.
“It seems Trump learned from Abe,” said a source familiar with the BOJ’s perspective, who preferred to remain anonymous due to the sensitivity of the issue.
Consequently, Trump’s actions could inspire governments worldwide, especially those with populist tendencies, to assert control over their central banks.
This could lead to globally higher inflation rates and more volatile markets.
“Taking over the Fed would set a dangerous precedent for other governments,” said Maury Obstfeld, a senior fellow at the Peterson Institute for International Economics and former chief economist at the International Monetary Fund.
“How can you observe what’s happening in the U.S., considered a bastion of institutional checks and balances and the rule of law, and not conclude that other countries are more vulnerable targets?”
