Trump is playing with fire by messing with the Fed

New York
 — 

President Donald Trump promised voters last fall he’d swiftly defeat inflation once back in the White House. Trump’s unprecedented and relentless attacks on the Federal Reserve could do the exact opposite.

While Trump is the first US president to try to fire a Federal Reserve governor, he’s hardly the first politician to seek lower interest rates.

Of course, presidents want to please voters with dirt-cheap mortgages, car loans and credit cards.

And it’s not shocking that a president would want to run the economy hot, opening the door to blockbuster GDP growth and record stock prices that would provide fodder for campaign ads.

Here’s the problem: The Fed is designed to be independent from political interference – and that’s no accident.

Economists and former Fed officials warn that Trump is playing with fire by messing with the Fed. They say that letting the White House call the shots on interest rates to please voters can backfire. And history backs that fear up.

“I feel uncomfortable about this. It seems like another attempt by the president to erode monetary policy independence. And that will lead to worse economic outcomes,” Narayana Kocherlakota, former president of the Minneapolis Fed, told CNN in a phone interview on Tuesday.

The first problem is that artificially low interest rates can overheat the economy, fueling inflation – the very problem Trump promised to solve.

Cheap borrowing costs typically stimulate demand – whether it needs to be stimulated or not. And overstimulating leaves too many dollars chasing after too few goods. That’s what happened after Covid-19, when inflation skyrocketed to four-decade highs.

Inflation is already running uncomfortably warm, with progress back towards to the Fed’s 2% goal stalling out in recent months in part due to Trump’s historically high interest rates.

Voters are already frustrated with the high cost of living. Messing with the Fed could exacerbate this problem.

The other big problem is that investors would be rattled if they suddenly fear the Fed has lost its independence – and its inflation-fighting appetite.

Critically, the Fed’s power comes in part from its ability to persuade markets and the public at large that it means business when it comes to keeping a lid on inflation.

If investors suddenly doubted the Fed’s commitment to low and stable inflation, they will obviously demand higher returns for making long-term loans. In other words, long-term interest rates – the ones controlled by investors, not the Fed, would go higher. And long-term rates are the ones linked to mortgage rates.

“The more the market thinks the White House is running Fed policy, the higher longer-term rates like mortgage rates will go,” said Kocherlakota, who served at the Fed until 2015 and is now a professor of finance at the University of Rochester.

Mortgage rates are already frustratingly high, spending most of the year stuck near 7%, contributing to the affordability crisis that has pushed the American dream of homeownership out of reach for far too many.

That’s the irony of Trump’s assault on the Fed: It risks undermining his campaign promise to drive down inflation. It could also exacerbate the No. 1 economic issue: the cost of living.

Inflation spiked after Nixon and Erdogan meddled

History shows this can end badly.

In 1970, President Richard Nixon tapped Arthur Burns, one of his top economic aides, to lead the Fed.

Even though Burns was known as an inflation fighter, historians say Nixon successfully pressured his handpicked Fed chief to juice the economy with low rates to boost his political fortunes.

A review of telephone conversations “clearly reveals that President Nixon pressured Burns, both directly and indirectly…to engage in expansionary monetary policies prior to the 1972 election,” according to a 2006 paper published in the Journal of Economic Perspectives. “Richard Nixon demanded and Arthur Burns supplied an expansionary monetary policy and a growing economy in the run-up to the 1972 election.”

By the late 1970s, prices were out of control.

Inflation eventually spiked beyond 13% in 1980 and unemployment surged in what later became known as the Great Stagflation.

More recently, Turkish President Tayyip Erdogan fired his country’s central bank chief in 2021 and installed a loyalist. As the Turkish central bank slashed interest rates at Erdogan’s behest, the Turkish lira crashed and inflation blew past 80%.

“History teaches us what can happen when a populist strongman decides to take over a central bank,” Justin Wolfers, an economist at the University of Michigan, told CNN in a phone interview.

Tim Mahedy, former senior advisor at the San Francisco Fed, described Trump’s attempted firing of Fed Governor Lisa Cook as a “naked attack on the independence of the Fed.”

Mahedy, now the CEO and chief economist at Access/Macro, said in an email to CNN that Trump has already “somewhat politicized monetary policy.”

“Trump is breaking the cardinal rule of central banking: Criticize, but don’t politicize,” Mahedy said. “He, and all of us, will pay a steep price if he’s successful in his pressure campaign – a cost that we would bear for generations.”