Fed changes course, takes on Trump’s political fight

Jerome Powell wanted to avoid a fight. That had long been his approach to handling President Donald Trump and his relentless attacks on the Federal Reserve, which in his second term had taken on heightened intensity.

Between an executive order wresting more control over the Fed's oversight of Wall Street to Trump's attempt to oust a sitting member of the policy-setting board of governors, the Fed had stuck to a time-tested strategy: Avoid provoking the president. At times, that meant bending to meet his demands in areas like climate change and bank regulation. But Powell, the Fed chair, drew the line when it came to protecting the central bank's autonomy to set interest rates.

A criminal investigation into whether Powell lied to Congress, revealed by The New York Times on Sunday, has prompted the central bank to jettison its cautious approach and fight. The battle's outcome could determine whether the Fed remains an independent entity.

"Trump is now exercising the nuclear option, so there is no longer a reason for Powell not to speak his mind," said Maurice Obstfeld, a senior fellow at the Peterson Institute for International Economics, who was formerly the chief economist at the International Monetary Fund.

Powell's decision to push back, which came in a rare video message Sunday evening, tees up the most challenging moment in his roughly eight years at the helm of the central bank. Powell, whose term as chair ends in May, must now decide how hard to continue fighting and whether to remain in his role as a governor, a term that is set to expire in 2028.

A ‘new threat'

Powell and staff members at the Fed worked through the weekend after the Justice Department served the central bank with grand jury subpoenas late Friday. What culminated was a two-minute video released Sunday evening featuring Powell bluntly calling out the administration for seeking to leverage a criminal investigation into costs related to the Fed's renovation of its headquarters as "pretexts" to coerce the central bank into lowering borrowing costs.

"This new threat is not about my testimony last June or about the renovation of the Federal Reserve buildings," Powell said Sunday. "The threat of criminal charges is a consequence of the Federal Reserve setting interest rates based on our best assessment of what will serve the public, rather than following the preferences of the president."

The Fed has cut interest rates only gradually, reducing them by 0.75 percentage points since September to a new range of 3.5% to 3.75%. Trump has demanded rates as low as 1%, calling Powell a "numbskull" and a "stubborn mule" for refusing to concede.

Friday's subpoenas relate to renovations that have been taking place since 2022 at the Fed's headquarters in Washington. The sprawling project, which is set to be completed in 2027, is $700 million over budget and is expected to cost roughly $2.5 billion.

Trump seized on the renovations as a new line of attack against the central bank this summer, accusing Powell of mismanagement and taking the rare step of showing up at the construction site for a tour. Legal experts saw it as the potential groundwork to try to remove the Fed chair for "cause," the only justification a president can use to lawfully fire an official at the central bank. Cause has typically meant gross malfeasance or a dereliction of duty while in office, although it has never been tested.

Powell's decision to respond directly by video reflected the explosive nature of the Justice Department's move. Never before has a Fed chair faced a criminal investigation. It also represented a stark departure from the administration's attacks on Powell to date, which had typically taken the form of personal insults from Trump. The president, who nominated Powell to the job during his first term, had also threatened to fire the Fed's chair, but had not acted on it. Still, Powell had preemptively retained outside counsel, hiring Williams & Connolly, a top litigation firm in Washington.

Trump instead tried to oust Lisa Cook, whom the Biden administration had appointed to the Fed. The president, citing allegations of mortgage fraud, said he had cause to remove her. Arguments for the case will be heard by the Supreme Court on Jan. 21.

Powell, a lawyer by training, and close advisers saw the Justice Department's investigation as a sharp escalation in the administration's affront against the institution that required a forceful response.

Trump denied having knowledge of the U.S. attorney's investigation, saying Sunday that he did not "know anything about it, but he's certainly not very good at the Fed, and he's not very good at building buildings," referring to Powell.

In the past, Powell had demurred from commenting directly on the president's attacks. Instead, he spoke in favor of the importance of the Fed maintaining its long-standing independence, a protection Congress granted the central bank so that officials set rates with an aim to attain low, stable inflation and a healthy labor market, rather than to the benefit of whomever is in the White House. But that changed Sunday.

"He didn't mince words," said Kenneth Rogoff, a professor of economics at Harvard University and a former chief economist of the International Monetary Fund. "He's tended to turn the other cheek, and he's reached a moment where he can't."

"The Fed seems to recognize that this administration rarely stops pressuring people and organizations to get what it wants, so anyone who won't capitulate to that pressure ultimately needs to fight back," added Douglas Elmendorf, a former director of the Congressional Budget Office who teaches at Harvard.

Powell on Monday got the backing of every living former chair of the Fed, as well as multiple former Treasury secretaries who called out what they described as "prosecutorial attacks to undermine that independence."

"This is how monetary policy is made in emerging markets with weak institutions, with highly negative consequences for inflation and the functioning of their economies more broadly," they wrote in a joint statement.

Janet Yellen, who served as Fed chair between 2014 and 2018 and was among the statement's signatories, said in an interview that the investigation constituted the most significant attack ever on the central bank's independence.

"The fact that he is willing to go that far to intimidate a Fed official suggests he's going to stop at nothing to get his way with respect to Fed policy," she said.

"If you can bring charges for no reason whatsoever against your enemies, we're no longer living in a society governed by the rule of law." She added: "That's the end of Fed independence."

Independence imperiled?

The guardrails protecting the Fed's independence were crafted by Congress to avoid a president having undue influence over major policy decisions that have significant sway over the trajectory of the economy.

One of the foremost protections revolves around the seven members of the powerful board of governors. Those officials are nominated by the president and confirmed by the Senate, but they cannot be fired at will. They also serve staggered 14-year terms.

Rate decisions are voted on by a 12-person committee made up of the members the board, the president of the Federal Reserve Bank of New York and a rotating set of four presidents from the 12 regional banks.

If Powell opts to stay on as a governor - something he has declined to publicly comment on - that would deny Trump the opportunity to appoint another member to the board.

"It's harder for him to go now," Scott Alvarez, the Fed's former general counsel, said of Powell. "If he goes now, it's under a cloud. If they hadn't done anything, he might have just left."

The president gained an unexpected vacancy in August when Adriana Kugler abruptly stepped down as governor after repeatedly violating the central bank's trading rules. He tapped for the job one of his top economic advisers, Stephen Miran, who took only a temporary leave of absence from the White House.

Trump is also in the final stages of selecting Powell's replacement for chair. Kevin Hassett, the director of the White House National Economic Council, is a top contender.

Appearing Monday on CNBC, Hassett said that he had "not been involved" in the Justice Department's decision to investigate the Federal Reserve. He said he had not been briefed on the matter, and that he would "expect" the president had not been as well.

Pressed repeatedly during the interview on the extent to which the president hoped to use the investigation to pressure the Fed to lower interest rates, Hassett at one point told CNBC: "In the fullness of time, we'll find out whether it looks like a pretext."

Asked Monday about the investigation, Karoline Leavitt, the White House press secretary, took the opportunity to criticize Powell.

"I do know one thing for sure, Jerome Powell is not very good at his job," she said in an interview with Fox News. "As to whether he's a criminal, that's an answer the Department of Justice is going to have to find."

In a sign that the investigation could have an impact on the Senate confirmation process, Sen. Thom Tillis, R-N.C., a member of the Banking Committee, on Sunday vowed to oppose any nominee for the Fed, including any coming chair vacancy, citing reports of subpoenas.

The investigation will also have broad implications for Cook's case. The Supreme Court will be ruling on how much latitude a president has to remove a Fed official and the extent to which they can define what constitutes cause.

"I hope the Supreme Court is watching, because it would eviscerate the independence of the Federal Reserve if the president could remove somebody on an allegation rather than on a finding of some criminal behavior," Alvarez said. "The fact that the DOJ has alleged this doesn't make it true."

Kathryn Judge, a professor at Columbia Law School, added that "the Federal Reserve will not remain independent if the president feels entitled to use every tool at his disposal to harass and intimidate Fed officials."

This article originally appeared in The New York Times.