The Fed is built to resist Trump's meddling

President Donald Trump hasn’t made any secret of his thinking on monetary policy: He intends to replace Federal Reserve Chair Jerome Powell with someone who will cut interest rates once they take over next year, if not sooner. Fortunately, America’s central bank was built to prevent such a coup from the executive branch. That’s why financial markets have been taking Trump’s antics in stride, try as he might to undermine the Fed’s independent, technocratic tradition.

First, Trump would have to win approval for his nominee in the Senate. The Committee on Banking, Housing, and Urban Affairs will host hearings with Trump’s pick, and lawmakers will size up the candidate’s seriousness before they even consider a vote in the full Senate. Granted, I’ve been recently disheartened by the way that Republican fiscal hawks spinelessly caved in to Trump’s irresponsible budget this month, but there’s a chance that even the president’s allies will draw the line at the integrity of our central bank. Consider, for instance, the failed nomination of Judy Shelton to the Federal Reserve Board in 2020 during Trump’s first presidency. Shelton, a gold-standard revivalist who was plainly unfit for the job, elicited an uproar among economists and former Fed staffers. Key Republican senators stepped up and refused to back her, a rebuke of the president at a time when his party had majority control in the legislative body.

Second, the Fed isn’t a dictatorship. The chair’s power isn’t absolute, no matter how Trump has painted his criticisms of Powell. The Federal Open Market Committee — the Fed’s rate-setting body — has 12 voting members at a given time (eight permanent and four rotators from the regional Reserve Bank system). In separate pieces of legislation passed between 1913 and 1935, U.S. lawmakers designed the FOMC to balance regional and national interests and to insulate monetary policy from political pressure. The permanent voters include the seven members of the Board of Governors, who serve staggered 14 year terms that are purposely out of sync with the political cycle. Beyond them, only the president of the Federal Reserve Bank of New York gets a permanent vote.

The other four voters cycle in and out annually from a cast of 11 regional Reserve Bank leaders, who are chosen by search committees formed by their own boards of directors, not the president. The Board of Governors ultimately has to approve of the appointments. In the sense that the governors are chosen by the presidents, there’s perhaps some White House influence in this process, but it’s extremely indirect. (This system didn’t stop Richard Nixon from influencing 1970s Fed Chair Arthur Burns, but Nixon was in the unique position, at one point, of having five of his own board appointees. Significantly, the Nixon experience ushered in a broader embrace of independence and transparency at the Fed that would be harder to undermine.)

It’s a bit hard to size up how many of today’s voters are Republicans, in part because many Reserve Bank presidents guard their political affiliations closely. Four of the seven current governors were Biden choices (an unusual wave of resignations gave Biden significantly more picks than is typical); two were holdovers from Trump’s first presidency; and Powell himself, the seventh, was named to the board by former President Barack Obama and promoted to chair by Trump. One Biden pick (Adriana Kugler) has a term that ends during the Trump administration. When Fed Board governors resign or otherwise leave prior to the end of their 14-year terms, their replacements serve for the balance of that original term. In Kugler’s case, she technically replaced Lael Brainard, so she’ll only serve from 2023 to 2026.

In a nutshell, even if Trump installs someone so blinded by loyalty that they’d knowingly lead the economy astray, he can’t orchestrate a regime change on the committee. Current Chair Powell could also retain his board seat once his chairmanship ends if he thought his replacement a reckless choice, though it would be the first time that a former chair did so since Mariner Eccles in 1948.

It’s worth acknowledging recent voting patterns on the FOMC, which have given some in financial markets the mistaken impression that the chair was all-powerful. Since the mid-1990s or so, dissents against policy decisions have become much less common, particularly among governors. That the public has the impression that dissent is dying is unfortunate, and I blame poor Fed communication and internal customs for allowing the idea to fester. It is, nevertheless, wrong.

There is still plenty of lively debate on the FOMC. Nowadays, a lot of that discussion happens before policymakers gather for their rate decisions. Unlike earlier eras, governors and Reserve Bank presidents spend many hours during the inter-meeting periods making their case to the public in speeches and interviews. In effect, the policy decision is litigated on CNBC and Bloomberg, and then everyone comes together and tries to project unanimity.

Is it a fake consensus? Probably, and I have plenty of reservations about this custom. But in the Fed’s defense, the artificial consensus has something of a purpose. The consensus era has coincided with the forward guidance era, when policymakers decided to more actively use forward-looking statements to influence market conditions to achieve their maximum employment and stable prices goals. Internal coherence was critical for forward guidance to be effective. My point is that the dissent is still there, even if the voting record suggests otherwise.

One final thing on Trump’s monetary policy schemes: No matter what happens, he’ll still have to answer to financial markets. If the president somehow manages to install a "yes man" at the Fed, and that person somehow manages to brainwash the FOMC into cutting rates for the wrong reasons, the most politically salient longer-term borrowing costs will inevitably rise, not fall. Yields on the 10-year Treasury note — a key benchmark for the 30-year fixed-rate mortgage and other consumer and business loans — are reflections of expectations about the economy over the longer run, and they’ll surge if investors think that the central bank is abdicating its responsibility to control inflation. Lessons of the recent ‘Liberation Day’ retreat suggest that Trump would see this and temper his worst impulses.

All in all, I still hope it never comes to this. As I wrote last week, the president’s best option for Fed chair is current Governor Christopher Waller, a Trump pick from 2020 who has distinguished himself with macroeconomic intuition and exceptional communication skills. Waller has the respect of markets and his colleagues, and he will act on the basis of sound macroeconomic evidence. But he should also be palatable to Trump since he’s recently made a case for rate cuts (on the basis of the data, not politics).

Even if Trump ignores that advice and tries to install a puppet, the good news is that the Fed’s rate-setting committee is well designed to stop him from causing too much harm.

This column reflects the personal views of the author and does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners. Jonathan Levin is a columnist focused on U.S. markets and economics. Previously, he worked as a Bloomberg journalist in the U.S., Brazil and Mexico. He is a CFA charterholder.