Central banks and governments have always had a difficult relationship. The independence of the central bank is not an automatically accepted good, but mostly the effect of bad experiences from phases of high inflation and periods of central banks dependent on periods. The world in which we live today in most Western-oriented countries was nourished not least by the experiences of the 1970s. The American central bank, the Federal Reserve (FED), although only founded in 1907 after the banking crisis of the same name, is undoubtedly the most important central bank of the post-war period, and thus developments affecting the FED must not only be judged from the US perspective, but also point the way forward for central banks all over the world.
What is currently at stake for the Fed cannot be explained without looking back to the 1970s. The Vietnam War had put a heavy strain on the finances of the USA, with Richard Nixon, former Vice President Eisenhower and an extremely strong and controversial personality, taking office as the 37th President of the USA in 1969. Nixon wanted a loose monetary policy and appointed Arthur Burns as the new Fed chairman in 1970. Arthur Burns had headed the President’s Council of Economic Advisors for several years during the time Nixon was Eisenhower’s Vice President, and was initially Counselor to the President after Nixon’s election victory.
MEAG ViEWWeakening the central bank’s credibility is not a good idea.
Arthur Burns pursued an expansive monetary policy – what would be called a very “dovish” policy today – even before the first oil crisis, and he repeatedly gave in to public pressure from the president and was also willing to “shape” the data on which decisions were based. For example, he did not shy away from pushing for corrections in the composition of the price statistics in order to be able to show the consumer price index lower.
Unfortunately, it is the case that in the event of high interest rates due to rising debt service, governments are tempted to expand their room for manoeuvre via “financial repression” – and one tool for this is low or negative real interest rates – and to take the risk of future inflation in favor of momentary growth impulses. On the other hand, the Bundesbank’s anti-inflation policy was accepted by the catastrophic German experience in the Weimar Republic. In the 1970s, this policy became a milestone in its impeccable reputation as a central bank committed to price stability and independent of the government. In the USA, the FED first had to earn this reputation again after the Arthur Burns period.
It is the noble right of the US president to appoint the head of the Federal Reserve, and the necessary confirmation by the Senate is traditionally a formality. At the end of his term in office, Jimmy Carter saw that a central bank that loses the confidence of the markets and the people is not only bad for inflation, but also for economic growth and the capital markets. It was Jimmy Carter who appointed Paul Volcker (and Ronald Reagan gave him a second term). Volcker defeated inflation and anchored inflation expectations. He and Alan Greenspan, who was appointed by Reagan towards the end of his term in office, created the basis for the Fed’s current standing over a period of 25 years. The current FED Chairman Jerome “Jay” Powell was selected by Donald Trump for this post in his first term in office, at which time the key interest rate was only 1.50 percent.
Because Jerome Powell’s selection was made by Donald Trump and the president proposes the Fed chairman, the president’s public attacks on the Fed chairman, the announcement that he will not renew his term, the massive criticism of the Fed, etc. are a serious event. The early resignation of board member Adriana Kugler shows that not everyone is up to this pressure, and the escalating situation around Lisa Cook is likely to further damage the institution, regardless of the final verdict. The nomination of Stephen Miran, the current head of the White House Council of Economic Advisors, as well as the dismissal of the Commissioner of the US Bureau of Labor Statistics, Erika McEntarfer, evokes unpleasant memories of the Nixon era.
The whole situation is paradoxical above all because the market (just like we have been since the beginning of the year) expects interest rate cuts by the FED from September onwards, as the growth and inflation picture suggest it. However, interest rate cuts after a phase of intense public pressure always carry the risk of being interpreted as a weakness of the institution. In this respect, after all the public accusations, the upcoming Fed interest rate cuts have the risk that, although they are justified and necessary in terms of content according to the latest labor market reports, they could also sow doubts about the institution.
Much will depend on the new Fed chairman, whom US President Trump is likely to announce before the end of this year, even if Powell’s term in office does not end until May 2026. At first glance, the latest short-list of candidates for possible FED successors with Waller, Hesset and Warsh appears acceptable to the markets in gradations. The new Fed chairman and his positioning will be a central part of the 2026 outlook. After all, the reputation of an institution is built up over decades, but it can be destroyed over months. A central bank with a reduced reputation would open the door to more inflation, steeper yield curves and a lack of confidence in successful crisis management, thus risking a significant deterioration in the capital market environment.
