THE PRESIDENT SHOULD NOT MEDDLE IN MONETARY POLICY

The following information was released by the Cato Institute:

Christian Kruse

"You're fired!" President Donald Trump's famous line from The Apprentice has been making a comeback since he returned to office in January, but a few days ago, he took it a bit too far by calling for the removal of Federal Reserve governor Lisa Cook. Federal prosecutors are investigating the governor for alleged mortgage fraud, accusing her of improperly listing two different homes as her primary residence. Trump deems the investigation enough evidence to fire Cook "for just cause." The governor disagrees.

,

Trump has been hounding the Federal Reserve for months to lower rates, publicly attacking the Fed and its chairman, Jerome Powell. But his latest move jeopardizes Fed independence and sets a precedent for removing Fed governors over matters unrelated to monetary policy. To safeguard Fed independence, Congress should require the central bank to follow a mathematical formula, a "rule," for setting rates.

Though other presidents have attempted to interfere (sometimes successfully) with monetary policy, this is the first time a president has ordered the removal of a Fed governor. But fiddling with monetary policy is a dangerous game.

,

The Federal Reserve's discretion-based system signals that interest rate decisions can be steered to reflect an administration's policy goals.

,

Just look at Turkey. Back in 2022, Turkish President Recep Tayyip Erdogan pressured Turkey's central bank to cut rates in response to high inflation a move that other central banks do not support. It did not go well. Turkey's annual inflation rate soared to 85% in 2022. For comparison, the United States at the same time hovered around 9.1%.

But Trump seems unconcerned about inflation, hoping that lower rates will offset the effects of his tariff policies. Despite his incessant pressure on the Federal Reserve, the central bank has maintained interest rate expectations over the past few months, concerned over post-pandemic inflation and upcoming tariff hikes.

While the Federal Reserve is more insulated from outside pressure than Turkey's central bank, its monetary policy is discretionary set through votes by the Federal Open Market Committee. So as long as the Federal Reserve claims it is following the dual mandate of stable prices and maximum stable employment, most simply grumble and concede that the bank's decision is the best direction for the economy.

But the Federal Reserve's discretion-based system signals that interest rate decisions can be steered to reflect an administration's policy goals. People can be pushed or prodded, and those on the FOMC may be no different. To avoid any such influence, the Fed should instead follow a rule when setting rates. This rule-based monetary policy would protect the Fed from criticism, as every decision would be backed by a clear and articulated methodology, eliminating any possibility that interest rates can be influenced by political pressure.

Additionally, rules-based monetary policy performs better than discretion. A Cato Institute report earlier this year underscores this point. The report compares actual Federal Reserve interest rate decisions to the rates that different monetary rules would have suggested. The findings show that rules more accurately predict economic shocks, such as exogenous spending, productivity, and wage markups, and reduce economic uncertainty.

The evidence is clear. To ensure the Fed's independence and provide more clarity over its decisions, Congress should require the central bank to follow a monetary rule. By following a rule, the Fed can quell uncertainty over which direction interest rates will head, dodging the heat from the media and White House over its discretionary decisions. Maybe then the president would stop trying to fire Fed governors or meddle with monetary policy.