Monetary policy is chiefly about two possibilities. Either central banks control inflation or inflation controls them. What's distinguishing, though, is that global central banks are nonpolitical entities and are free from electoral and political pressures to tame inflation.
But in an unfortunate turn of events, the US Federal Reserve is under pressure to follow the preferences of President Donald Trump. In other words, the sacred tenet of central bank independence, where policymakers can set rates without interference from governments and politicians, is once again under strain, wrecking confidence and credibility in monetary policymaking.
That Trump has been ratcheting up pressure on Fed chair Jerome Powell is nothing new. He has been lobbing insults against Powell calling him a stubborn mule, incompetent, crooked, Mr Too Late and so on. Just this week, he hurled another calling him a jerk.
Powell maintained calm brushing aside Trump's intense witch hunt. But he broke his silence after the US Department of Justice issued subpoenas, threatening a criminal indictment over a $2.5 billion expense to renovate the Fed's headquarters.
In an unprecedented move, Powell shot back with a measured response, escalating tensions between the central bank and the Trump administration.
"This is about whether the Fed will be able to continue to set interest rates based on evidence and economic conditions, or whether instead monetary policy will be directed by political pressure or intimidation," he stressed in a video statement released on Sunday.
In no time, a slew of global central banks, former Treasury and Fed officials, and private bankers have all rallied behind Powell, warning that political pressure on the Fed risks undermining financial and economic stability worldwide.
First, the Bank of International Settlements (BIS), along with governors from 11 major central banks, vowed to stand in full solidarity with Powell. The signatories include Christine Lagarde, of the European Central Bank, Andrew Bailey, of Bank of England, Tiff Macklem, of Bank of Canada, and others.
"The independence of central banks is a cornerstone of price, financial and economic stability in the interest of the citizens that we serve. It is therefore critical to preserve that independence, with full respect for the rule of law and democratic accountability. Chair Powell has served with integrity, focused on his mandate and an unwavering commitment to the public interest. To us, he is a respected colleague who is held in the highest regard by all who have worked with him," they noted.
Next, CEOs from Wall Street banks like JP Morgan Chase too voiced support insisting that putting central bank independence at risk could backfire and push interest rates and inflation up. This was followed by former Fed and Treasury officials, including Ben Bernanke and Alan Greenpsan, Timothy Geithner, Henry Paulson and others, issuing a joint statement against the investigation in general and defending Powell in particular.
"The reported criminal inquiry into Federal Reserve Chair Jay Powell is an unprecedented attempt to use prosecutorial attacks to undermine that independence," observed their dispatch.
Lastly, former Fed chair Janet Yellen too joined the chorus, strongly condemning the investigation, saying it compromises Fed's independence, and further adding that financial markets should be concerned about a situation that's 'extremely chilling.'
In fact, the threat to Fed independence was expected to make financial markets revolt. But they remained poised. The dollar weakened, but only slightly, while US treasuries saw modest selling pressure. Perhaps markets believe the fuss will fizzle out on its own, even though analysts worry that political influence over rates risks higher inflation and fuel global market volatility.
Interestingly, some believe that concerns over Fed's independence are being overstated, with the real risk to the central bank stemming from its own internal expansion rather than political pressure on rates, according to William Lee, Chief Economist and Managing Director at Global Economic Advisor. He argued that political attacks gained traction largely because of Fed's operating expenses, which have quadrupled over the past two decades.
That aside, Lee also reasoned that the latest attacks are largely rhetorical and well understood by markets, which has seen even worse episodes like in 1965 when President Lyndon Johnson physically confronted then-Fed Chair William McChesney Martin over interest rates during the Vietnam War.
Trump has been pressuring Powell to ease rates since assuming office in 2025, blaming his policies for holding back the economy and even threatening to fire Powell.
As on December, the effective interest rates stand at 3.64%, following a 0.25% rate cut last month. Although the Fed is in an easing cycle, it's likely to hold rates in its next meeting as labour conditions are relatively stronger and don't warrant an immediate rate reduction.
This may have triggered Trump's ire to replace Powell with a dove, who would deliver regardless of whether the economic conditions warrant what is being sought. Such a move will lower borrowing costs, but the implications extend well beyond the US. Moreover, an ultra-loose monetary policy stokes inflation, and weakens the Fed's ability to respond if the economy slows down as witnessed in the past.
For instance, during the 1970s, former Fed chair Arthur Burns succumbed to pressure from President Richard Nixon to keep rates low, stoking inflation so high that it earned him the unwanted title of being the worst Fed chair in history.
The emotional scars are forever etched fresh in investors' memories, who bat for an independent Fed to determine short-term rates, which then will be fed into long-term borrowing costs like mortgages by financial markets. Importantly, investors demand higher yields on government bonds, which in turn raises borrowing costs, if they sense that inflation remains persistent. Above all, the Fed wields extensive power, not just over the US economy, but also influences global markets, which mirror Fed's rate hikes or cuts depending on domestic economic conditions.
When central banks cut rates, borrowing becomes cheaper, encouraging spending, accelerating growth and creating jobs. When they raise rates, borrowing becomes expensive, moderating demand and cooling down labour market.
Economists have long advocated central bank independence, as it insulates policymakers from political pressures to maintain price stability. If central banks become entangled in partisan politics, not only their credibility suffers, but also inflation becomes harder to control.
Meanwhile, as Powell nears the end of his term in May, uncertainty is high about where the Fed's monetary policy is heading at a time when inflation remains above the Fed's 2% target, and the labour market is showing signs of cooling.
Even though Powell's term ends in May, he has the right to remain on the Fed board until January 2028, denying Trump another Fed appointment. As the Supreme Court last year ruled, a president cannot fire the Fed chair just because he doesn't like the chair's policy choices.
However, Trump may be able to remove Powell for a cause, typically interpreted to mean some kind of wrongdoing or negligence. The criminal indictment against Powell, some believe, stems from this direction.
