“Relief in Prices for American Families and Combating the Cost of Living Crisis” is the title of one of several executive orders issued by President Donald Trump in his first week back in the Oval Office. This executive order directs federal agencies to “provide extraordinary price relief” to the American people by reducing federal regulations that raise the cost of or limit the supply of health care, housing, energy, and other goods and services.” Eliminating regulations is an effective way to reduce costs and increase supply in affected industries. However, price increases caused by regulations are specific to specific sectors. Economy-wide price increases are caused by the Federal Reserve. Widespread price increases are the result of inflation. Inflation occurs when the central bank lowers interest rates by increasing the money supply. In remarks ahead of the World Economic Forum’s annual meeting in Davos, Switzerland, Trump said he would soon meet with Federal Reserve Chairman Jerome Powell to “demand” the Fed lower interest rates to help Americans cope with high prices. 
Adding more money to the economy may give some consumers a temporary boost in their purchasing power, but a long-term effect of the cut will be to further erode the standard of living of most Americans, as the influx of new money causes the dollar to lose value—and therefore their real incomes.
The short-term benefits of any increase in the money supply and reduction in interest rates are felt primarily by the wealthy, since they receive the new money before other Americans. They thus enjoy increased purchasing power before the Fed’s inflationary policies cause prices to rise.
Interest rates are the price of money—as money has become a commodity. As with all prices, interest rates inform market participants about the conditions prevailing in the market regarding the supply and demand for goods and services. When the central bank manipulates interest rates, it distorts the signals sent to market participants, causing a misallocation of resources.
The result is a “bubble” that produces a short-term boost in employment and incomes. However, the bubble will eventually burst, causing a recession, a decline in total output. Just as middle- and lower-income Americans suffer most from Federal Reserve-induced price increases, they are the primary victims of the Fed-induced recession.
The best thing Congress and the Fed can do when a bubble bursts is to let the recession run its course. Recessions are necessary to remove the distortions caused by the Federal Reserve’s easy-money policies.
Of course, Congress and the Federal Reserve refuse to follow the sensible, if politically difficult, path. Instead, they have set the stage for the next bubble through stimulus spending and low interest rates.
President Trump claims to know more about interest rates than Federal Reserve Chairman Jerome Powell. Whether President Trump’s experience in real estate development (a business that is very sensitive to changes in interest rates) makes him more of an expert on interest rates than Powell is beside the point.
No politician, bureaucrat, or central banker can know exactly what the right interest rate is. The only way to know what the right interest rate is is to allow individuals operating in a free market to set it by their own choices.
The Changes Ahead
While Trump has made noise about whether to fire Powell or attempt to gain direct control over interest rate decisions, Trump’s latest clash with the Fed reopens the door to a radical possibility that the central bank, as most have known it for decades, could change.
On the campaign trail and since taking office, Trump not only advocated lower interest rates, but said he would “demand that interest rates be cut immediately,” as he told attendees at the World Economic Forum’s annual meeting last week. Lower interest rates tend to boost stock prices and make it cheaper for people to borrow money, often boosting a president’s popularity. But lowering interest rates can also fuel higher inflation. 
Powell, who has been at the helm of the Fed since 2018, has argued that as members of an independent government agency, Fed officials have no obligation to the president or any elected official. Moreover, when asked by a reporter in November whether Donald Trump could fire or demote him or his colleagues on the Fed board, Powell replied curtly: “It’s not allowed under the law.
Independence is the Fed’s mainstay – but does it exist?
“Price stability is the foundation of a healthy economy and provides the public with immeasurable benefits over time,” Powell said in a speech two years ago. “But restoring price stability when inflation is high may require measures that are unpopular in the short term, as we raise interest rates to slow the economy.”
That’s the theory… but central bankers are proving to be servants of many masters… When the Fed began raising interest rates in the spring of 2022, Powell was receiving most of his criticism from Democrats — especially Senator Elisabeth Warren of Massachusetts, who accused him in a hearing in June of that year of sacrificing American jobs to fight inflation. warning that it would “push the economy over the edge.”
At the time, the Fed had been aggressively raising interest rates to tame inflation, which hit a 40-year high in 2022. The Fed’s actions that year significantly raised borrowing costs for Americans and the stock market had its worst year since 2008. Without the rate hikes, inflation, now approaching the Fed’s 2% target, could have remained elevated, adding to the financial stress many Americans are already experiencing.
But this is a problem that the Fed itself created with its interventions since the 2008/2009 financial crisis and the pandemic… The Fed has (partially) put out the fire it started.
Theory and Practice
Central banks with a higher degree of independence, measured by factors such as whether politicians cannot easily fire rate-setting officials and whether government officials can sit in on policy meetings or overturn decisions, generally have lower inflation.
The reason for this, Powell pointed out, is that greater independence frees central bankers from having to bow to short-term political pressures, which can often lead to inflationary policies. This also helps create more stable economic growth over the long term.
But by the same token, central banks have better economic outcomes when they are accountable to the legislature and operate under political mandates such as the Fed’s, which requires the bank to target an annual inflation rate of 2% and a maximum employment rate.
If efforts to undermine the Fed’s independence are successfully challenged, it would be akin to “abolishing the institution.”
The Cost of Bowing to Political Pressure
The Fed is widely considered an independent institution, based in part on interpretations of the 1913 law that established it and the reforms brought about by the Banking Act of 1935. But its independence, which is highly valued by Wall Street, is a characteristic that has earned its legitimacy throughout history. However, there have been times when the Fed has not acted independently, which has come at great cost.
In the 1970s, when Arthur Burns ran the Fed, he was known for his relationship with then-President Richard Nixon. At the time Nixon was campaigning for reelection, the U.S. economy was showing signs of inflation. This should have prompted the Fed to begin the painful process of raising interest rates to curb upward pressures on prices, but, knowing it would hurt Nixon’s ratings in the polls, Burns resisted tightening monetary policy.
The Fed’s lack of independence in this situation contributed to a painful period of persistently high inflation, former Fed Chairman Ben Bernanke argued in his book on monetary policy in 2022. Once Paul Volcker took over as Fed chairman, inflation was finally fought, and he did so largely by making policy decisions based solely on what the economic data showed, not what a sitting president demanded. That commitment to data-driven behavior has stuck ever since.
Recognizing the Fed’s failures in the 1970s, Congress amended the Federal Reserve Act in 1977 to include additional reforms, such as requiring the Fed chairman to report to Congress twice a year to document the central bank’s activities.
This was expanded upon in the Banking Act of 1935, which separated the Fed from the Treasury Department to minimize partisan influence and established the Fed’s policymaking committee in its current form. The assumption that the law is the sole source of the Fed’s independence is false, but the converse assumption, that the law is irrelevant, is also false.
How Trump Could Deal with Fed Rebellion
The Banking Act of 1935 states that the president can remove members of the Fed’s Board of Governors, the group of Fed officials that includes Powell who are responsible for setting interest rates along with the regional presidents of the Fed’s reserve banks “for a variety of reasons.”
A 1935 Supreme Court case, Humphrey’s Executor v. United States, set a precedent on how much power the president has to remove agency heads.
The case involved William Humphrey, “a conservative commissioner on the Federal Trade Commission who was fired by Franklin Roosevelt in 1933 over political differences,” the Brookings Institution wrote in a 2018 analysis.
History aside, however, the Court will likely also consider the economic implications of curtailing the Fed’s independence and its ability to carry out its congressionally authorized functions.
For example, U.S. bond yields, which affect the interest rates Americans pay to borrow money, “could soar,” a reflection of heightened political risk that would contribute to “greater policy uncertainty and higher inflation expectations.” The Federal Reserve is generally politically dominated and has driven monetary policy to serve political ends, causing the U.S. debt to skyrocket to about $37 trillion in a fiscal derailment that is also weakening the real value of the dollar and the assets of American citizens. Trump may demand that the Fed chairman meet with him and be held accountable for decisions. On the campaign trail, Trump said, “I feel like the president should at least have a say there. I feel that strongly,” referring to the Fed’s interest rate decisions. “I’ve made a lot of money. I’ve been very successful. And I think I have better instincts than, in many cases, people who would be at the Federal Reserve — or the president.” But after a barrage of backlash, Trump tried to soften that position. “A president can certainly talk about interest rates because I think I have a very good sense. That doesn’t mean I’m making the plan, but it means I should have the right to be able to talk about it like anybody else.” Ordering the Fed chairmen and other officials to meet with President Trump would likely be a much easier task than removing the chairmen and other members of the Fed’s board. That’s because the Constitution specifies that the president “may request the opinion, in writing, of the chief officer in each executive department, on any Subject relative to the Duties of their respective Offices.” Trump deserves credit for publicly criticizing the Federal Reserve. President Trump should follow up his criticism of the Fed by working with Congress to pass legislation to control the Fed and legislation that allows people to use alternative monetary solutions such as precious metals and cryptocurrencies. Restoring freedom to the money market is key to fulfilling Donald Trump’s inaugural pledge of a new golden age for the United States
