DAVIDSON, N.C. (TNS) — The first few months of Donald Trump’s nonconsecutive second term as president have been marked by controversial economic initiatives. First, he proposed excessively high tariffs, prompting fears of a global trade war. The second has been Trump’s challenge to the independence of the Federal Reserve system. Trump joins Richard Nixon in dangerously pressuring the Federal Reserve to engage in self-serving monetary policy.
The Federal Reserve system was officially established in December 1913 during the first administration of Woodrow Wilson. Despite its decentralization with 12 regional banks, the system has the broad ranging responsibilities of a central bank. In particular, influencing interest rates to promote its dual mandates of price stability and sound economic performance through monetary policy is a central task charged to its Federal Open Market Committee.
The Federal Reserve system is meant to be independent of external governments pressures. The president appoints the chair of the Fed and its governors, all subject to senate approval and confirmation. Once appointed to terms that stagger with the president’s, the conduct of monetary policy is to be independent of executive or legislative pressure to promote any short-term political gain.
A near totality of economists approve of the principle of Fed independence, and the executive branch has generally respected that policy.
Since 1913, we have seen only two significant breaches of this principle. In both cases they have involved controversial Republican presidents who tried to pressure the Federal Reserve to lower interest rates to promote short-term economic activity and employment.
In both cases, expansionary monetary policy was not appropriate for the long-term health of the economy.
Let’s review both cases.
Many readers will remember that just a few months ago, Trump clashed with Fed Chair Jerome Powell. Much to Trump’s chagrin, the Federal Reserve has refrained from lowering the federal funds rate below 4.5%. Fearing a slowing economy, Trump publicly called upon Powell to lower interest rates. Then, when the Fed kept the rate flat, Trump threatened to remove Powell from office. While this action may not be legally possible, few actions or threats could be more challenging or threatening to the chair of the Federal Reserve Board.
An outcry against Trump coupled with great international financial market instability led Trump to back away from such overt threats. Nevertheless, the public could see the potential damage that self-serving intervention into monetary policy could cause.
Fewer readers may be aware of Nixon’s more covert effort to pressure the Federal Reserve in the early 1970s.
Inflation turned into 1970s stagflation
Nixon inherited a challenging economic situation from President Lyndon Johnson, who opted not to run for reelection in 1968. Serious inflation was a challenge that, with concurrent wage increases, was turning into stagflation in the early 1970s. No policy inspired by John Maynard Keynes’ guidance on government involvement in the economy could simultaneously address both inflation and unemployment as problems.
Fearing an adverse impact on his 1972 reelection campaign, Nixon took measures for short-term political gain that were harmful for the economy.
In August 1971, Nixon announced widespread wage and price controls. They suppressed inflation in the short term, but led to shortages and hidden inflationary pressures in the long term. The Nixon tapes show that administration officials interacted repeatedly with Fed Chair Arthur Burns to convey their concern and their expectation that Burns would pursue a more expansionary monetary policy to stimulate the economy.
Burns did, in fact, implement an expansionary monetary policy, and we don’t know how much Nixon influenced Fed policy. But the key, unambiguous conclusion is that the Nixon administration tried, inappropriately, to influence the actions of the Federal Reserve, violating its independence.
Most important, the combination of Nixon’s self-serving wage and price controls and Burns’ expansionary monetary policy crippled the U.S. economy for the remainder of the 1970s. It took the highly restrictive monetary policy with double-digit interest rates promulgated by subsequent Fed chairs during the mid- to late 1970s to remedy the inflation problem.
This is a clear reminder that politics can undermine monetary policy — and that the Fed and the White House should remain permanently independent.
(Clark G. Ross is the Frontis Johnston Professor of Economics, Emeritus, at Davidson College in Davidson, North Carolina.)
