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After almost a year of Donald Trump’s sustained attacks, the Federal Reserve is under pressure. If presidential name-calling, threats to fire Fed chair Jay Powell, an ongoing attempt to fire Fed governor Lisa Cook and an explicit demand for lower interest rates to alleviate the cost of government debt were not enough, the Fed is also accused by Treasury secretary Scott Bessent of exceeding its powers since the financial crisis.
With this background, the Peterson Institute for International Economics could not have picked a better time for last week’s excellent conference on central bank independence, which was admirably free of pearl clutching and unrealistic defences of everything the Fed has done.
Everyone agreed that independence should not be a goal in its own right and the right to set monetary policy free from political interference was justified only by results. That was about as reassuring as it got for central bankers.
Economists disagreed
After allowing US banks to become too big to fail, getting involved in climate policy and overseeing 10 per cent inflation, there is some significant support among economists for Bessent’s view that the Fed’s poor choices in the past have highlighted excessive independence and this should be reined in. John Cochrane of the Hoover Institution, for example, felt that the Fed needed a much more limited mandate to operate independent of government and much stronger lines of accountability.
His view generated a typically provocative response from Larry Summers of Harvard and a former Treasury secretary. Summers said that any complaints about the Fed exceeding its mandate were “not among the top 100 problems that the nation faces” and, instead, said much greater harm could come from the Trump administration’s threats to the central bank.
“Were there to be the idea that the Fed should subordinate itself to unconventional ideas about monetary policy driven and generated by the executive branch of the US on an ongoing basis, that would be, with overwhelming probability, adverse to the interests of the republic and a higher order issue and a higher order concern,” Summers said.
Markets are not bothered
However worked up economists get about threats to the Fed, financial markets have been calm all through 2025.
Francesco Bianchi of Johns Hopkins University presented updates to his previous work showing that Trump’s rude comments about the Fed on social media in his first term led to a statistically significant drop in financial markets expectations for the fed funds rate. Bianchi found this has been the same in 2025, showing that markets think Trump’s threats work and the Fed responds with lower rates.
For longer-term time horizons, however, the president’s words do not have much power, but nor was there any sign of bond vigilantes limiting the president’s actions with expectations of higher inflation.
Randy Kroszner, former Fed governor and Bank of England Financial Policy Committee member, noted that there had been little financial market concern that Trump’s actions would lead to higher medium-term inflation rates (chart below).
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Perhaps this non-reaction was because Fed independence was not that important, perhaps because the threats had not been that bad, perhaps because the candidates for next Fed chair were seen as credible, perhaps because the Supreme Court was treating the Fed differently from other public bodies or perhaps because the US dollar is the world’s primary reserve currency.
All these reasons were plausible. But no one could prove their pet theory because all explanations were consistent with the facts. The upshot, however, is clear. Bond vigilantes are not coming to rescue the Fed from threats to its independence.
Lawyers worry
One of the main theories why markets have been sanguine was that the US Supreme Court has made it clear it will treat the Fed differently to other US government agencies. In May, when ruling that an official could not return to her job while her case against being fired without cause was going through the courts, the majority on the Court said the Fed was a different beast to other agencies.
“The Federal Reserve is a uniquely structured, quasi-private entity that follows in the distinct historical tradition of the First and Second Banks of the United States,” it said.
This ruling appears to have reassured many in markets and economics, but lawyers worry about the lack of principle or logic behind the Supreme Court’s position.
Stephen Vladeck, of Georgetown Law School, said that “in its rush to embrace the unitary executive theory . . . [the Supreme Court] still wants to come up with some way to carve out the Fed even if that way is completely, utterly and unredeemably analytically unpersuasive”.
The weakness of the Supreme Court’s arguments might well mean the Fed is not as safe as it thought in May, especially with the Court having to rule on Trump’s definition of “cause” in the Lisa Cook case next year.
Public legitimacy waning
If lawyers were not as optimistic as financial markets, nor were academics who have been examining public attitudes to the Fed. They recall that in Milton Friedman’s 1962 essay Should There Be An Independent Monetary Authority, the economist asked whether it was “really tolerable in a democracy to have so much power concentrated in a body free from any kind of direct, effective political control”.
The answer to Friedman’s question, according to Carola Binder of University of Texas at Austin, was that legitimacy of Fed independence in the eyes of the public is what makes it tolerable. But she added that there were ample warning signs that Fed legitimacy was on shaky ground, especially with attitudes towards the agency becoming increasingly partisan. As the chart below shows, Trump’s attacks on the Fed have undermined its legitimacy among Republicans this year with a plurality disapproving of its actions.
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Don’t reason from a price change
Last week I highlighted remarkable research showing that US 10-year government borrowing costs decreased only on days around Fed meetings until 2022. Then, I attributed the breakdown of this relationship since then to the Fed’s waning influence. When the Fed meets, borrowing costs fall, but they have risen sharply at other times since 2022.
There is nothing wrong with the numbers, but a few readers worried about the inference I drew. The same Randy Kroszner who was speaking at the Peterson conference got in touch to say that the movements might be a sign of better Fed communication, with markets knowing more about the Fed’s reaction function further ahead of meetings, so those dates no longer matter so much.
He’s right. That is a plausible alternative explanation, although we cannot distinguish between waning influence and clearer communication from the price change alone. Yet another example of why it is dangerous to reason from a price change.
What I’ve been reading and watching
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In her first speech since Donald Trump started a process of attempting to fire her, Fed governor Lisa Cook placed views bang in the middle of others on the Federal Open Market Committee on Monday. She saw risks to both sides of the Fed’s prices and employment mandates and was watching things carefully. Although Cook said explicitly she could not comment on her legal case, she showed a sense of humour, saying “one day if I ever get back into the classroom — and I don’t want to do that too soon — this is a teachable moment”. (50 mins)
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The five candidates to be Fed chair unless Trump picks Bessent instead
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The Fed says a December cut is not a foregone conclusion, while the European Central Bank is still in a good place
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US financial deregulation marches on
One last chart
Alberto Cavallo, Paola Llamas and Franco Vazquez have a new paper comparing detailed prices charged by major US retailers and Trump’s tariffs on the same goods. I have highlighted the rise in import prices relative to domestically produced goods before but the paper has been extended to include an estimate that tariffs have added 0.7 percentage points to US inflation in September.
Instead of the 3 per cent inflation in September reported by the Bureau of Labor Statistics, it would have been around 2.3 per cent without tariffs. The tariff effect has been adding gradually but the authors estimate that pass through is still only 20 per cent because retailers have been taking the pain so far.
The chart below shows the latest results and is generated by the researchers estimating a pre-tariff trend in prices of a disaggregated series of goods and the divergence of that trend after tariffs were imposed. It’s a rough and ready approach, but gives a sense of the important counterfactual: what would US inflation have been without Trump’s tariffs.
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