What Powell needs to do now to keep the Fed independent

Blaming the Federal Reserve for economic disturbances is a common political pastime in the U.S. Still, even by their usual standards, politicians' recent attacks on the Fed are unprecedented and risk serious damage to the Fed's credibility.

President Donald Trump has called Fed Chair Jerome Powell a "numbskull" and a "stupid person." Vice President JD Vance has said the Fed's refusal to cut rates is "monetary malpractice." Commerce Secretary Howard Lutnick told Powell that his "job is to help Americans, not hurt them."

Juvenile name-calling aside, the Trump administration's attacks on the Fed highlight the problems with Fed discretion and obscurity. How does one measure the accuracy of such criticisms and objectively evaluate the Fed's performance?

The Trump administration's attacks on the Fed highlight the problems with the central bank's discretionary moves.

For instance, the Fed clearly failed at keeping inflation low and stable in the aftermath of the COVID-19 pandemic. Instead of raising its target rate, the Fed labeled inflation "transitory" and kept its target too low for too long. But although the Fed's failure is clear in hindsight, the consensus at the time did not expect inflation to go so far over trend.

The best way to judge the Fed's performance is to compare its rate decisions to those prescribed by common monetary-policy rules.

For instance, most common rules recommended the Fed raise rates beginning in late 2020, well before the central bank did so in January 2022, by which time inflation had become entrenched. Post-pandemic inflation is not an isolated example. Academic research has shown that macroeconomic outcomes are better when the Fed follows a rule than when it acts discretionarily.

The good news is that, by committing to rules-based monetary policy, the Fed can both improve its macroeconomic performance and shield itself from political attacks. Under such a framework, the Fed would publicly announce its formula to determine the appropriate value of its key policy interest rate — the federal-funds rate (FFR). Most monetary policy rules function as feedback systems, guiding the Fed's FFR target based on the current state of key macroeconomic indicators such as inflation and unemployment.

Given the economy's interconnected nature and the tendency of these indicators to move in tandem, the policy recommendations from different rules tend to be similar. Indeed, the data bear that out. The potential macroeconomic-stability benefits from most common rules are similar, and all of them are better than pure Fed discretion. Arguments over which specific rule the Fed should follow should not stand in the way of committing to a monetary policy rule.

Unsurprisingly, the Fed disagrees with a rules-based approach. It has argued against such an approach in the past, though it has not made a persuasive case. This is despite the Fed often taking credit for the Great Moderation period from the 1980s through the early 2000s, marked by stable inflation and unemployment.

Interestingly, this is the same period where the Fed seemed to (unofficially) follow a rule. The criticism most often levied at rules-based monetary policy is that it is overly restrictive and would handcuff the Fed. However, any rules-based framework can easily account for the possibility of exigent circumstances. For instance, the FORM Act proposed in 2015 allowed the Fed to pick the rule it wished to follow. The Fed could update the rule at determined intervals, but could deviate from its rule only if it explained and defended its reasoning to Congress.

Aside from the macroeconomic benefits, rules also shield the Fed from the kind of political backlash it has faced recently. Not that politicians will stop blaming the Fed even if it switches to a rules-based regime; blaming the Fed for poor economic outcomes is too easy and too accepted for politicians to stop doing so. The central bank can, however, instill more faith in the process by assuring markets that rate decisions are happening apolitically. That is in addition to the clarity such rules offer market participants in the first place, since no one will be required to guess what the Fed's latest rate decision will be.

The good news is that the Fed's 2025 framework review is currently under way. It is the perfect opportunity for the Fed to help itself and all market participants by committing to a rules-based monetary policy. If not, Congress must impose such rules on the Fed, reining in discretionary monetary policy and shielding the Fed from wanton political attacks that undermine its credibility.