- President Donald Trump has publicly criticized the Federal Reserve's current path of interest-rate hikes for the third time in a month.
- The criticism revived concerns about the US Federal Reserve's political independence.
- Presidents have pressured the Fed before, most notably Richard Nixon.
- Nixon convinced then-Fed Chairman Arthur Burns to keep interest rates low, leading to nearly a decade of economic problems.
US President Donald Trump once again broke with White House convention on Tuesday, criticising the policies of the Federal Reserve and its chair, Jerome Powell.
In an interview with Reuters, Trump said he was "not thrilled" by Fed chairman Jerome Powell's decision to raise interest rates and would continue to criticize the Fed if interest rate hikes continued. It followed reports earlier in the day that Trump had criticised Powell at a private GOP fundraiser.
Trump's criticisms of the Fed are nothing new. The president made similar comments in an interview with CNBC as recently as late July. But the latest comments remain significant given the long-standing tradition that presidents do not comment on matters of monetary policy.
While the White House attempted to assuage concerns by reiterating the president's support for the Fed's independence, the comments raise the spectre of a huge policy mistake made in the 1970s.
Richard Nixon, the Fed, and stagflation
The Federal Reserve's structure is unique within the US bureaucratic system. It operates within government but simultaneously remains relatively independent, with only some oversight from Congress.
The Fed's independence is couched in the belief that for a central bank to achieve its aims — ensuring financial stability and long-term growth — it should be free from the pressure that might be exerted by politicians seeking to alter policy for their own ends, rather than putting the country's prosperity first.
The most notable example of a president violating this edict of independence occurred under Richard Nixon in the 1970s.
In the run-up to the 1972 election, Nixon wanted to present the country with a strong economy and low unemployment. To do so, Nixon swapped out Fed Chairman William McChesney Martin with his pick, Arthur Burns.
Nixon pressured the new Fed chairman to keep interest rates low to help maintain lower unemployment. The released Nixon tapes revealed numerous conversations between the president and Burns in which Nixon pressures the Fed chair to keep rates low. Nixon even told advisers "we'll take inflation if necessary, but we can't take unemployment."
Burns did, in fact, keep rates relatively low but it proved to be disastrous as it helped to usher in a period of stagflation — high inflation, high unemployment, and low economic growth.
Not until Paul Volcker took over the Fed nearly a decade later and ratcheted up interest rates in what is known as the "Volcker Shock" would the issue be truly corrected.
Other incidents, including President George H.W. Bush complaining about the policies of his Fed chair, Alan Greenspan, have also occurred, but Bush's comments were far more muted than Nixon's extended pressure.
Defenders of Fed independence point to the Nixon example to support their argument that politicians should not attempt to tamper with monetary policy. There is also empirical evidence to support this claim.
Gregory Daco, chief US economist at Oxford Economics, pointed to research by Alberto Alesina and Lawrence Summers that showed in countries with a politically influenced central bank had higher inflation.
"While reviewing 16 OECD economies, they showed that countries with independent central banks generally had lower inflation without 'suffering any output or employment penalty'," Daco said. "As such, central banks acting outside of the political sphere of influence would be most desirable in any country."
While Trump is far away from Nixon's level of interference, Daco said it is an important theme to keep an eye on.
"While current conditions are very different from those of the 1970s, we must not forget that the premise of central bank independence rests on the advantage of insulating monetary policy from short-sighted political objectives," he said. "While inflation expectations are currently well anchored, history shows us that a pervasive lack of central bank independence can rapidly, and without warning, lead to rising inflation and economic instability."
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