Trump’s Fed fight looks like something from another country

A political leader demanding questionable policy from the central bank and testing the legal limits to get it – to Martin Redrado, sitting in Argentina, Donald Trump’s stand-off with the Federal Reserve feels surprisingly familiar.

Redrado was fired as head of Argentina’s central bank in 2010, after he resisted orders by then-President Cristina Kirchner to hand over reserves to help pay off national debts.

He fought the decision successfully in court, but eventually resigned in the face of what he told the BBC was “intolerable” pressure.

Today, the clash is remembered as one of the early warnings of the economic turmoil that later engulfed Argentina, exposing it to high inflation and a currency plunge from which the country is still recovering.

Trump’s fight with the Fed has sparked debate about whether the US might be heading in a similar direction.

Since his return to office last year, Trump has accused the chair of the US central bank, Jerome Powell, of mishandling the economy and driving up debt costs for the government by keeping interest rates too high.

But his interventions at the bank have not been limited to social media complaints.

In August, Trump moved to sack a top policymaker, Lisa Cook, a decision now being challenged at the Supreme Court.

Then on Sunday, Powell said the Fed was facing a criminal probe from the Department of Justice, relating to cost overruns at a property renovation – concerns that Powell has dismissed as “pretext”.

Market reaction to the drama has remained muted, which analysts said was a sign that investors expect the bank to be able to continue operating freely.

But that faith will be tested in the coming weeks, when the Supreme Court is due to hear arguments about Cook’s firing and the president is expected to announce his pick to replace Powell, whose term as Fed chair ends in May.

Redrado said he has been surprised to see echoes of his own battle happening in the US, long held up as a global model.

“This seems more like an emerging market story,” he said.

He is not alone in making the comparison.

“This is what you do in banana republics, not what should happen in the United States of America,” economist Jason Furman, who led former President Barack Obama’s Council of Economic Advisers, told the BBC, using a derogatory term often used to describe countries with unstable politics and economies subject to the whims of a ruling class.

In an interview with CNBC, former Fed chair Janet Yellen, who served as Treasury Secretary under Joe Biden, raised a similar spectre as she warned against the way Trump wants the Fed to conduct policy. “It is the road to a banana republic,” she said.

Trump has remained defiant in the face of calls to limit his interference with the bank, a powerful economic player, which has access to vast financial reserves and the ability to influence borrowing costs across an economy.

He has denied involvement in the criminal probe, which he said had nothing to do with interest rates, while maintaining he has a right to express his views.

“I think it’s fine what I’m doing,” he said.

But economists say Trump keeps up his attacks at the risk of the economy, arguing that hard-won evidence shows central banks deliver the best results when they operate without political pressure.

That consensus emerged from painful run-ins with inflation in the 1970s, including in the US, leading to a wave of global reforms.

Extensive academic research has since linked central bank independence to lower inflation over time.

Experts say elected officials have too many incentives to try to use bank power to secure an immediate economic boost or satisfy particular constituencies, even if it might hurt the economy over the long run.

But though Trump’s pressure on the Fed is unprecedented for the US, the president is hardly the only head of state to disregard advice to leave central bankers alone.

In the UK, former Prime Minister Liz Truss has attacked the Bank of England, criticising its independence and accusing it of having too much power.

A study of central banks in 118 countries between 2010 and 2018 found roughly 10% of central banks each year faced pressure from political leaders, like Trump, wanting lower interest rates, which make borrowing less expensive and can deliver a short-term economic boost.

Pressure on central bankers was most likely to emerge in countries with nationalist or populist leaders and was typically followed by higher inflation, says economist Carola Binder, a professor at the University of Texas at Austin who conducted the review.

In Turkey, for example, President Recep Tayyip Erdogan cycled through three central bank leaders in three years between 2019 and 2021, as he looked for someone who would execute on his unorthodox view that high interest rates fed inflation.

Inflation soared past 50%, as the bank bowed to his demands, before he agreed to appoint leaders with more moderate views.

Even in countries where central banks resisted the interference, Binder’s research found that inflation tended to rise, albeit to a lesser degree, suggesting pressure alone could cause damage.

Binder says she thinks the pressure led people to doubt central banks’ ability to manage inflation effectively, causing them to expect higher prices in the future – a view that is often self-fulfilling.

For now, polls suggest inflation expectations in the US remain contained, making the likely significance of the current fight more political than economic, Binder says.

Still, she warned: “That is a possibility for the US – that this could be inflationary.”

Even if the Fed became a tool of the president, analysts believe the US economy was unlikely to face as severe a fallout as smaller nations like Argentina and Turkey.

But some say there are already signs the fight is having consequences, pointing to an 8% fall in the value of the dollar against a basket of currencies over the last year.

Over the long term, it can be hard to identify the driver of economic damage – whether it is the loss of central bank independence or other, often related issues, like the erosion of democracy or rule of law, says Carolina Garriga, professor of political science at the University of Essex.

But she says immediate market moves, like a dip in the dollar that followed the announcement of the Fed criminal probe, show investors consider central bank independence an important piece of the puzzle.

“It’s hard to disentangle but it is not hard to disentangle when it’s market reaction to an announcement.”

Since the criminal probe became public, key Wall Street leaders and members of Congress, including some Republicans, have spoken up forcefully in defence of the Fed.

At the Supreme Court, justices have also indicated that they see the bank as different from other arms of government, where they have let Trump’s firings proceed.

Analysts say they think the Fed will be able to maintain confidence in its policies, noting that it sets interest rates via a committee with 12 members, of whom the president appoints only seven and who each have long, staggered terms.

“There is slight concern,” says Jennifer McKeown, chief global economist at Capital Economics. “But there’s not a switch here that says faith in US institutions has been lost and therefore we’re in a downward spiral.”

But much of the Fed’s reputation for independence is rooted in convention, rather than legal design. In global comparisons of central bank independence, as measured by legal features, the Fed ranks in the bottom third.

Redrado said he remained hopeful that the strength of US institutions would prevail, unlike in Argentina, while warning that Trump was running unnecessary risk.

“President Trump is really defeating himself by having this kind of fight,” he said. “He should know better.”