Brick by brick: Fed independence
Two foundational protections of the Fed’s independence in monetary policy are under threat: the tenure of Fed officials and the control of its budget.
Last Wednesday, for about an hour, it seemed as though the day had arrived, and President Trump would fire Fed Chair Powell. The reaction in financial markets to the initial reports was swift: longer-term Treasury yields rose, the dollar fell, and stocks declined. It quickly reversed when the President said he was “not planning” to fire Powell, and it was “highly unlikely … unless he has to leave for fraud.”
Today, a little more than a week later, President Trump will be touring a construction site at the Fed, making him only the fourth president to visit the Fed. The $2.5 billion renovation of two historic buildings at the Fed has come under intense scrutiny, including allegations of mismanagement of funds and accusations of perjury by Powell in his testimony before Congress regarding the project. Holding the Fed accountable to explain the renovation is important. If the cost is used to build a case for external controls on the Fed’s budget, that could undermine its independence more than firing the Fed Chair.
Independence requires protection.
Why is Fed independence in monetary policy so important? Independent technocrats, not political operatives, setting interest rates is widely viewed as crucial for controlling inflation. Throughout history and around the world, there are examples of politicians advocating for lower interest rates to stimulate economic growth or reduce the government's borrowing costs. Such policies can increase demand beyond the economy’s productive capacity, leading to inflation. An independent central bank offers a bulwark to those political tendencies.
The forces of political influence are strong, so Fed independence requires institutional protections. As an FAQ on Fed independence on the Board website explains, the Fed is not subject to Congressional appropriations:
The Federal Reserve does not receive funding through the congressional budgetary process. The Fed's income comes primarily from the interest on government securities that it has acquired through open market operations. After paying its expenses, the Federal Reserve turns the rest of its earnings over to the U.S. Treasury.
The Fed’s budget is not a tool that Congress or the White House can use to influence the Fed’s decision-making. That is a powerful protection and one that few federal government agencies have. It protects the Fed from being included in a rescissions package, such as USAID and NPR/PBS (where the White House asked Congress to cancel previously approved spending), or threatened with cuts to federal funding, as seen at Columbia and Harvard Universities.
Another important protection is the structure of the Board:
The Congress established maximum employment and stable prices as the key macroeconomic objectives for the Federal Reserve in its conduct of monetary policy. The Congress also structured the Federal Reserve to ensure that its monetary policy decisions focus on achieving these long-run goals and do not become subject to political pressures that could lead to undesirable outcomes. So, members of the Board of Governors are appointed for staggered 14-year terms, and the Board Chair is appointed for a four-year term. Elected officials and members of the Administration are not allowed to serve on the Board.
While the 7-member Board is designed to have a voting majority on the 12-member FOMC, no one President should have the ability to nominate the entire Board. The number of openings varies as many Board members resign before their term as Governor is over. Currently, President Trump is set to have at least two openings in his term: one in January 2026 (Kugler) and one in January 2028 (Powell), though he might leave when his term as Chair ends in May 2026. Firing Powell from the Fed Chair would not significantly alter the math at the Board, even if it were highly disruptive.
The existence of these institutional protections is a testament to the fact that political influence poses a real threat to monetary policy and a recognition that the potential damage to the economy without Fed independence would be substantial. Even so, Congress can alter those protections. If the Fed were partisan, incompetent, or profligate in its spending—as the Administration has argued—then Congress could have reason to remove the Fed’s special protections.
Fed independence is a continuum, not an either-or. Firing the Fed Chair would not strip the Fed of its control of monetary policy, but it would be an unprecedented step in that direction. Keep in mind that with the repeated public criticisms of Powell by the White House, as well as explicit guidance from the President on interest rates, we are already moving along that spectrum toward less independence. Arguably, the most problematic move against independence is the President setting a ‘litmus test’ of lowering rates for candidates for the next Fed Chair. So far, none of these events has significantly altered the Fed’s credibility as an inflation fighter; market-based measures of inflation expectations remain fairly stable.
The cost of independence.
The Fed’s costly renovation of two buildings has recently come under scrutiny from the Administration and some Republican members of Congress. It may even develop into a case for the White House to consider firing Powell “for cause.” Even if it does not reach that step, the scrutiny of the renovation could damage the Fed’s reputation as a good steward of its resources and call into question its control of the budget.
The price tag of $2.5 billion for renovating two buildings is substantial. Even before the cost overruns, the initial estimate of $1.9 billion would not win in the ‘court of public opinion.’ It’s hard to imagine another federal government agency getting approval for such a sum. The Fed didn’t need approval. It approves its own budget.
Andy Levin, a former economist at the Fed, who has been critical of the renovation, put the numbers in perspective:
When the Eccles-1951 project is completed, the Fed’s HQ will be one of the most expensive structures in the world. For example, the buildings owned by the U.S. Congress—including the Capitol, six congressional office buildings, the Library of Congress, and the U.S. Botanical Garden—have a combined valuation of $2.6 billion. The Bank of America building (a 55-story skyscraper in Manhattan) was completed in 2009 at a cost of about $1 billion—the equivalent of $1.6 billion at current construction prices. JPMorganChase has spent about $3 billion on its new 60-story HQ.
Levin’s characterization of it as “Versailles Palace on the Mall” is unfair, though the renovations probably could have cost less (at least from a design perspective). The Fed has tied the cost overruns to inflation and challenges of renovating historic buildings from the 1930s in an area with strict architectural standards and a high water table.
In his critique, Levin argues that the Fed needs an independent Inspector General to instill spending discipline. There should be more external oversight. An external IG might sound like a sensible step, but it’s also a change that could expose the Fed to more political influence.
It’s a real threat. Since the start of his second term, President Trump has removed more than 20 inspectors general of agencies. These actions have been viewed as a means to discourage investigations into waste, fraud, and abuse within the administration. If the Fed’s IG were organized like Cabinet agencies (where the President appoints and the Senate confirms), it, too, might have been purged and redirected to serve the administration’s goals. It is not ideal to have an IG who is an employee of an agency (as is the case with the Fed), but there are risks to having an ‘independent’ IG who is external as well. Note, Powell recently requested that the Fed’s IG conduct a review of the renovations.
The scrutiny of the Fed’s renovation is set to last some time. President Trump is visiting the site today. Yesterday, Senator Tim Scott, the Chairman of the Senate Banking Committee, requested additional details on the renovation. There is an aspect of transparency and accountability, which is welcome, but there is a risk of weakening the protections of independence. Firing Powell ‘for cause’ over the renovations or pushing for external control of the Fed’s budget would make it harder for the Fed to conduct monetary policy independently.
In closing.
The protections of Fed independence are necessary, and they are not free. A 14-year term for governors protects the Fed from each president restaffing the Board, but it also mutes the consequences for making policy mistakes. Any institution without a hard budget constraint will tend to spend more than if it had a constraint. The constraint on the Fed is its accountability to Congress (which created and can alter the Fed), but that differs from being an at-will employee or having a budget set externally.
The renovation of the Fed that should concern us is not at Constitution Avenue; it’s at Pennsylvania Avenue. $2.5 billion for a building renovation is a significant amount of money, but it is nothing compared to the costs to a $30 trillion economy if the Fed were under political control. Each brick that the White House removes from the Fed’s credibility weakens the Fed’s independence and puts the economy at risk.
Do you think we might eventually see the world starts to shift away from the U.S. dollar’s status as the dominant reserve currency at an increased speed — even if it remains extremely important? I’m just wondering, especially given the persistent budget deficits, the freezing of Russia’s dollar reserves (which China has surely taken note of), and the increasing political pressure on the Fed (for example what you described in the article).
On the whole, I very much appreciate this description and analysis. But one paragraph troubles me a little — let’s break it down into a couple of parts:
“Independent technocrats, not political operatives, setting interest rates is widely viewed as crucial for controlling inflation.”
“Widely viewed,” eh? But by whom? I suspect very much by those for whom the current arrangements are congenial. Unfortunately, current arrangements are very much uncongenial for broad swaths of working Americans.
“Throughout history and around the world, there are examples of politicians advocating for lower interest rates to stimulate economic growth or reduce the government's borrowing costs.”
Indeed — and these aren’t in and of themselves necessarily bad things, correct?
“Such policies can increase demand beyond the economy’s productive capacity, leading to inflation.”
Yes. Yes, they “can” but that is NOT the same as “will” or “must.” The outcome depends upon matching expenditure to real resource availability, including labour. So how do we ensure the match? One suggestion follows:
“An independent central bank offers a bulwark to those political tendencies.”
Sure — but that isn’t the sole solution, is it? I would submit that it’s very much a “second best” solution compared to judicious fiscal policy — a tool vastly more flexible and powerful than monkeying with the blunt instrument of overnight rates as a feeble alternative.
I submit to you that “independent” (scare quotes because the Fed is a creature of Congress and its laws) central banks are, by design, aristocratic (spare me “technocratic” — it’s merest obfuscation) institutions inimical to labour. Further I submit that they serve as a convenient bulwark against something else entirely — the systems of democratic accountability to which our elected representatives would otherwise be subjected for their fiscal policy failures. As such I welcome a return to the consolidated Treasury and an end to abdication of responsibility by our elected representatives for exercising one of the most fundamental tools of sovereign statecraft — fiscal policy and monetary policy working together on behalf of the citizenry.