Fed today, Fed tomorrow

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Fed Chair Powell has warned that there are “no risk-free paths now.” He’s referring to the challenging situation for the Fed with the risk of inflation persistently above target and the risk of employment weakening. Reduce rates to support employment, and the Fed might fuel inflation. Hold (or even raise) rates to fight inflation, and the labor market could deteriorate.

Powell’s warning applies to the Fed itself, too. The risk of political interference in setting interest rates is at its highest level in living memory, with the President trying to remove Fed Governor Lisa Cook. Even if the Supreme Court upholds the Fed’s tenure protections and the Fed maintains its operational independence, the risk remains that President Trump will install new Board members who will alter its current, data-driven, non-partisan approach.

Stephen Miran’s first week as a Fed Governor underscores the risky paths facing the institution. He dissented in favor of a larger 50-basis-point cut and argued that White House economic policies align with 150-basis-point lower rates before the end of the year. Treasury Secretary Bessent, who is vetting candidates for the next Fed Chair, praised Miran for “doing more in his first week than the Obama nominees in their entire tenure.” Bessent stressed that in the Chair, he wants someone who is likewise “open-minded” and “looking forward, not backward.” Miran is an outlier at the Fed now, but he’s also a window into where the Fed is heading.

We will know the Fed by the way it works.

Last week at the press conference, Powell was asked how, on the outside, we would know if the Fed were no longer independent. Powell’s answer covered what the Fed is (data-driven) and what it’s not (politics-driven):

Look, it's deeply in our culture to do – to do our work based on the incoming data and never consider anything else. That's just – everybody here who's at the Fed really feels strongly about that way. So, you know, you'll know it by the way we talk about what we're doing, by the speeches that people give, by the decisions that we make. You'll know that we're just still going to do that. That's all we do.

And we don't – we don't frame these questions at all or see them in terms of political outcomes. I think when you get to another part of Washington everything is seen through the lens of does it help or hurt this political party, this politician. You know, that's the framework. And I think people find it hard to believe that that's just – that is not at all the way we think about things at the Fed.

We're taking a longer perspective. We're trying to, you know, serve the American people as best we can. So I think – I think you would be able to tell. I don't – I don't believe we'll ever get to that place. You know, I would say we're doing our work exactly as we always have now, and people are – they're making their arguments and we're having really a great discussion around these challenging issues. [Emphasis added.]

Grappling with data is the sign of an independent Fed. Under Powell’s leadership, we have seen the Fed undertake both aggressive easing and aggressive tightening. The economic conditions, outlook, and balance of risks that drove the policy shifts were tied to the data.

What was striking about Stephen Miran’s first speech? He didn’t engage much with the data. His justification for 150 basis points in cuts within three months rested on his assumptions about how the trade, tax, regulatory, and immigration policies of the Trump administration are affecting the neutral rate of interest, the output gap, and future inflation. It’s a useful conceptual exercise, but how can monetary policy be “very restrictive” and necessitate a series of large rate cuts when actual inflation is moving up and the unemployment rate remains low historically? Miran’s theoretical approach to the neutral rate is the opposite of Powell’s ‘we will know it by its works’ approach.

To be clear, Miran does not stray overtly into being concerned with “political outcomes,” which Powell said would be the mark of a captured Fed. Miran is also laudably transparent in his thinking. However, the shift away from data-driven policy is a development to watch, especially with the impending start of a new Fed Chair. The risks to the Fed are not limited to a loss of independence; the loss of a firm anchor in reality is also a risk.

Winning the argument.

Another journalist asked Powell how politics might already be influencing the Fed’s actions. Miran is the first person since the 1930s to serve as a Fed Governor while also a White House official (on leave). Powell pushed back on the concern:

So there's 12 voters – 19 participants, of whom 12 vote, as you know, on a rotating basis. So no one voter, you know, can really – the only way for any voter to really move things around is to be incredibly persuasive. And the only way to do that, in the context in which we work, is to make really strong arguments based on the data and one's understanding of the economy. That's really all that matters. And that's how it's going to work. And I think that is the way the institution – that's in the DNA of the institution. That's not going to change. [Emphasis added.]

Miran has been embracing this challenge in his speeches and interviews over the past week. He’s not alone. Sixteen of the 19 Fed officials have spoken in public this week.

In all likelihood, Miran will remain an outlier at the current Fed. Even though he is speaking the language of mainstream monetary policy, including r-star, potential output gaps, and Taylor rules, he will not persuade anyone on the FOMC who does not already agree that tax cuts in the reconciliation bill more than pay for themselves or that foreigners are bearing the full cost of tariffs. The implications of those two assumptions alone knocked almost a percentage point off his calculation of the neutral funds rate.

Persuasion is not the only path to change policy. People matter. Who is likely to agree with Miran? The next Fed Chair. It would not be hard to see frontrunners like Kevin Hassett and Kevin Warsh agreeing with Miran. The Fed Chair has more ‘powers of persuasion’ than a Fed Governor. The Chair can direct hundreds of staff working on issues related to monetary policy, sets the agenda of the FOMC, and has the largest public platform. Imagine if the Chair gave Miran’s speech—how would financial markets react? We are not far from finding out.

Even with Miran as Governor and a new Trump-selected Fed Chair, that would only change monetary policy so much. Persuasion and a tempering of views would still be necessary to get enough votes for a majority on a 12-person FOMC. Congress created the staggered 14-year terms for Governors to limit how quickly a President could exert an influence on the makeup of the Fed. That critical safeguard is at risk with the President trying to remove current Fed Governor Lisa Cook. If Trump is successful, the person who would replace her would almost certainly agree with Miran. The same would be true with the next Governor the President tries to fire after Cook.

Packing the Fed is faster than persuading the Fed. When Powell appeals to the “DNA of the institution” in persuasion and says, “That's not going to change,” he is implicitly assuming that the political attacks on the institution will not succeed. The culture of the Fed reflects its long-standing institutional safeguards. Without those safeguards, the culture would change.

Independence on the line.

This week was marked by Fed officials offering their views on how restrictive monetary policy is, whether and when another rate cut might be warranted, and the risks to employment and inflation. The investors listened carefully, and financial markets also reacted as this week’s data generally struck a more resilient tone. That is all business as usual in a world with a data-driven, independent Fed.

It’s not business as usual. The Supreme Court is currently considering whether Lisa Cook should be removed from her Governor role while her court case moves forward. Thursday was the deadline for her filing with the court and for any amicus briefs.

Greenspan, Bernanke, and Yellen—the three living former Federal Reserve Chairs—signed an amicus brief in support of Cook remaining in her role, along with several former Treasury Secretaries and Council of Economic Advisers Chairs of both parties. In making the case for central bank independence, the brief explains how the Fed would change if the President were in control:

Elected officials face a different set of pressures and incentives. Because elected officials are accountable to voters every few years, they have an incentive to respond to their constituents’ immediate interests by prioritizing short-term economic growth and employment over long-term stability. For example, elected officials often favor lowering interest rates to boost employment, particularly leading up to an election. Although that approach may satisfy voters temporarily, it does not lead to lasting gains for unemployment or growth and can instead lead to persistently higher inflation in the long-term and thus ultimately harm the national economy.

They also draw the connection to Cook’s case:

Together, the staggered terms and for-cause removal protection provide the Board “with distance and independence” from politics, and prevent any President from forcing out Governors who “act contrary to the president’s immediate preferences.”

If the Supreme Court allows the White House to remove Cook while her case proceeds, it would change the ‘math’ at the Fed quickly. The President would quickly nominate someone to fill her role ‘temporarily,’ and Senate Republicans would confirm that nominee, sending a clear message. Persuasion would no longer be necessary to move monetary policy. The ability to remove and replace Governors on unproven allegations would open up anyone, including Powell, to the same treatment as Cook. The Fed without tenure protections is a very different Fed.

In closing.

There are no risk-free paths for the Fed. That’s true in any moment of transition in the Board members and in the leadership. With change comes risks. However, there are risks of a fundamental redefinition of the Fed. It’s one thing to downplay data; it’s another to become a political arm of the President.

The DNA of the Fed is at risk, and that’s a risk to our economic prosperity.