U.S. President Donald Trump,after repeatedly criticizing and pressuring Federal Reserve Chair JeromePowell, took another shocking action that stunned the markets. He publiclyposted a letter on his social media addressed to Federal Reserve Fed GovernorLisa Cook, announcing her immediate dismissal. This move is nothing short of unprecedentedin the history of the Fed.
The motivation behind Trump'sunconventional actions is largely understood by most market institutions as anattempt to change the Fed's monetary policy by reshaping its board ofgovernors. Before this, Trump had repeatedly criticized Powell, accusing himand the Fed under his leadership of not cutting interest rates quickly enough.According to media reports, Trump had also considered removing Powell from hisposition as the chair, which was supposed to end next year. Some officials fromthe Trump administration had also repeatedly criticized Powell for hishesitation to lower interest rates. These politically motivated attempts toinfluence the Fed's actions have increasingly posed a threat to the principleof central bank independence, a cornerstone of the U.S. financial system, andcould undermine the foundations of both the U.S. and global financial markets.
However, in order to maintainthe stability of the U.S. economy and reduce the cost of government debtfinancing, Trump clearly focused more on his own political future to achievehis "MAGA" political goals. Trump stated that he would soon have a"majority" of Fed Board members appointed by him, who would supporthis desire to significantly lower interest rates. Moreover, even if legalprocedures prevent Trump from directly firing a Fed governor, he could stillundermine Powell by appointing a successor next year who agrees with his stanceon rate cuts. This would allow him to influence the Fed's monetary policydecisions. This means that the independence of the Fed would face anunprecedented threat.
An article from The Wall StreetJournal suggests that Trump's actions could mark the end of the FederalReserve's independence, which has been in place since 1951. The article statesthat regardless of whether Trump's intentions ultimately succeed, this eventcould become one of the most pivotal moments for financial markets in decades.If the White House eventually gains control over monetary policy, the U.S.could enter an era of higher inflation and greater volatility. In fact, ANBOUND'sfounder Kung Chan has warned that this "Trump Shock" could very wellrepeat the scenario and consequences of the "Nixon Shock". In theshort term, monetary policy may lean more towards easing, which could befavorable for the real estate and bond markets. However, in the long term, thepoliticization of monetary policy could lead to prolonged stagflation and adepreciation of the U.S. dollar, under the condition of the absence of competitivedevaluation.
A rather perplexing question iswhy Trump would relentlessly "repeat the mistakes" of pressuring theFederal Reserve. From an economic perspective, aside from the increasinginfluence of the U.S. government on markets and the economy, it is also crucialto recognize that the economic foundation of the Fed's monetary policyindependence is increasingly being eroded.
In fact, the "NixonShock" was understood at the time as a sign of the failure and end ofKeynesian government interventionist economic policies. After successfullyovercoming the Great Depression, Keynesianism, which advocated for using governmentspending to influence the economy, became widespread in the post-World War IIera. This not only met the needs of post-war economic reconstruction but alsoaligned with the self-interest of ruling parties in various countries, whosought political gains from supporting economic development. However, thecontinuous expansion of fiscal spending led governments, including the U.S.,into a vicious cycle of rising deficits and increasing debt. At that time, U.S.President Nixon started advocating for interest rate cuts, which marked a casewhere political views influenced the Fed's decision-making. The result was theonset of stagflation. On the one hand, the stimulative effect of persistentfiscal expansion weakened over time; on the other hand, inflation became a"beast" that was hard to control. The failure of Keynesianism gaverise to the rise of neoliberalism, where monetarism, which focuses onregulating the economy through money supply and reducing direct governmentintervention, became the dominant policy framework. This was reflected in theReagan administration's push for supply-side reforms and reducing governmentmarket intervention, while Fed Chair Paul Volcker raised interest rates tocombat inflation, helping the U.S. navigate the difficult 1980s.
The contraction of the government's role under neoliberaleconomic theory has made the role of monetary policy increasingly significant,turning central banks into the main actors in policymaking. In this regard, thesuccessful practice of monetarism created the myth of Alan Greenspan as the"economic czar" of the U.S. for two decades, and it establishedcentral bank independence as a core policy principle for major economies.However, after Greenspan's departure, the 2008 financial crisis revealed cracksin monetarist theory and gave Ben Bernanke, who had spent his life studying theGreat Depression, the opportunity to implement large-scale government marketinterventions through "new Keynesianism". Unprecedented"quantitative easing" and market bailouts allowed the U.S. to facethe once-in-a-century crisis.
However, on one hand, the market failure during the crisis madeit difficult for the "free market" advocated by neoliberalism tojustify itself, leading fiscal policy to re-enter the policymaker's agenda. Onthe other hand, the prolonged period of low inflation, low interest rates, andlow growth after the crisis caused monetary policy, which primarily relied oninterest rate and liquidity adjustments, to gradually lose its effectiveness.Japan and Europe fell into the trap of "zero interest rates" and"negative interest rates," and the U.S. faced similar issues, i.e., lowgrowth, difficulty in raising interest rates, nearly non-existent inflation,and continuous debt expansion fueling asset bubbles.
In particular, Japan's long-termmonetary easing has failed to lift the country out of its economicdifficulties, becoming a classic counterexample that has led many to questionmonetarist theory. As it stands, Japan's current efforts to emerge from the"lost decades" have relied not only on monetary easing but also onstronger fiscal policies to drive structural reforms, as well as theimplementation of "new capitalism". This approach is essentiallysimilar to the "monetary + fiscal" rescue plan pushed by BenBernanke, representing an integrated policy path that combines both fiscal andmonetary measures. Moreover, the impact of the COVID-19 pandemic has furtherstrengthened the role and position of fiscal policy within the broadermacroeconomic policy framework.
Of course, the Fed's own policyfailures have further eroded its authority and independence. One of the reasonsthat many, including Trump, criticize the Fed is its handling of high inflationafter the pandemic. The Fed's "hesitation" in responding toinflation, with neither anticipation nor preparation, and its delayed actions,have led to its continued involvement in the inflation issue. Trump evenreferred to Powell as "Mr. Too Late". In reality, this loss ofcontrol over policy is a direct consequence of long-term"ineffective" monetary policy. On the one hand, prolonged lowinflation and low interest rates have limited the scope for monetary policyactions. On the other hand, the divergence between inflation and unemploymenthas left the Fed in a difficult position, unable to act decisively in eitherdirection.
At the recent global centralbank conference, the Federal Reserve adjusted its monetary policy framework,abandoning the "average inflation targeting" strategy that had led topolicy delays, and instead returned to the "flexible inflation targeting"framework used half a decade ago. Powell reflected that five years ago, theU.S. economy was in a "new normal", i.e., low growth, low inflation,and an extremely flat Phillips curve, with interest rates long near theeffective lower bound (ELB). Since the 2008 financial crisis, the policyinterest rate had remained at the ELB for seven years. At the time, it waswidely believed that if another recession occurred, rates would return to nearzero and remain constrained for a long time, further suppressing employment andinflation, creating a vicious cycle. Therefore, in 2020, the Fed introduced the"average inflation targeting" framework to ensure that inflationexpectations would remain anchored at 2% even when interest rates wereconstrained. However, the situation after the pandemic was completelydifferent, with the economic reopening leading to the highest inflation in 40years. This was something the Fed had not anticipated.
What surprised the Fed was thesignificant changes in inflation after the pandemic. In particular, thedivergence between inflation and unemployment data has left it in a difficultposition. In this regard, in the era of deglobalization, the relationshipbetween inflation and money is showing new changes. The connection betweenmoney and inflation is shifting, as is the relationship between inflation andemployment, which is causing the monetarism of the globalization era togradually "fail". In fact, even before the pandemic, both"universal basic income plans" and "modern monetary theory"emphasized the role of government fiscal policy, and they essentially proposedintegrated fiscal and monetary policy frameworks. Under this trend, theweakening of central bank independence is a result of monetarism's cyclicaldecline. Regardless of the consequences, this may be the policy foundationbehind Trump's current push to consolidate his control. However, unlike in thepast, if the Nixon Shock ended the practical application of Keynesianismthrough its counterexample, Trump's actions may mark the beginning of thecyclical end of monetarism.
Final analysis conclusion:
To realize his stance oninterest rate cuts, U.S. President Donald Trump is pushing for thepoliticization of Federal Reserve monetary policy in an unprecedented way. Thisthreat to the central bank's independence, beyond political maneuvering, isalso rooted in economic fundamentals and the changing financial system amid thetrend of deglobalization. These shifts are driving the once globally dominantmonetarist economic theory toward its cyclical end. The decline in the Fed'sindependence may mark the beginning of this economic theoretical shift. Inshort, Trump's logic has its inevitability; it is just a matter of time for theWestern financial world to acknowledge it.
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Dr. Wei Hongxu is a Senior Economist of China Macro-Economy Research Center at ANBOUND, an independent think tank.
