Play Stupid Fed Games, Win Stupid Fed Prizes

Trump's economic problems are fiscal, and even the most pliant monetary authority wouldn't be able to fix them.

Dear readers,

An inconvenient fact about the Federal Reserve — one that has circumscribed President Trump’s actions in his war on the bank — is that despite its power to set interest rates, it does not really control borrowing costs.

The Federal Open Market Committee sets short-term interest rates, but if it sets those rates too low, it will spur inflation. And while its policy actions influence longer-term interest rates, like mortgage rates, the Fed doesn’t control those rates directly. All else equal, lower short-term rates should tend to pull down long-term rates, at least a little. But if market participants think lower rates portend higher inflation — or if they believe the Fed will have to hike rates later to offset inflation caused by near-term rate cuts — then Trump could get the short-term interest rate cuts he’s been demanding and see mortgage rates stay steady or even rise. Indeed, the Fed’s rate cuts in 2024 produced no apparent benefits for mortgage borrowers.

Compared to what the Fed controls, the chair of the Fed controls even less. The FOMC has twelve voting members — all seven members of the Federal Reserve Board and five presidents of regional Federal Reserve Banks — and the chair acts more as a forger of consensus than a CEO. Most of the sitting members of the board have terms that will outlast Trump’s term as president, so a new chair won’t necessarily be able to materially reorient our country’s monetary policy even if he or she wants to.

I think this explains why, for all his bluster, President Trump has not yet actually tried to fire Jerome Powell. Central bank independence is usually discussed as a mechanism to prevent politicians from prioritizing short-term gain over long-term pain. But it is not obvious that Trump would enjoy any short-term gain by wresting control of the Fed. If he got what he says he wants — a pliant Fed that sets short-term rates at 1% — his prize might well be higher inflation, a lower stock market, and no improvement in mortgage rates. Better to tell everyone that Powell is the reason it’s so expensive to borrow money right now than to fire him and still have that problem, but with no scapegoat.

Though it would be unwise to defenestrate Powell, Trump may still try to do so. The pretextual outrage over the expensive renovation of the Fed’s headquarters is an obvious effort to create an option for firing him. But there’s a less drastic way for Trump to use the renovation as a stick: as a pressure mechanism to get the Fed to move a little faster, a little sooner, on rate cuts. The Fed faces a genuinely difficult-to-analyze economic situation — it’s unclear how much inflationary pressure remains and how much the labor market might be weakening — and some Fed board members are making perfectly plausible arguments that the time is right for some modest cuts. Trump similarly put his thumb on the scale for dovish Federal Reserve action in 2018 and 2019, and he eventually got what he asked for, though it’s unclear how much his pressure influenced the Fed to make the rate cuts it made.

The Federal Reserve building is seen under construction on July 17, 2025 in Washington, DC. Office of Management and Budget director Russell Vought has asked the Powell to respond to a series of questions about cost overruns in the nearly $2.5 billion renovation by July 21st. (Photo by Michael M. Santiago/Getty Images)

That said, the president is probably overestimating how much he’d benefit politically from some modest rate cuts, since those cuts might not flow through into lower long-term rates and would create at least modest upward pressure on prices.

The reason there isn’t much juice for the president in the Fed is that the primary economic policy challenges facing the country today are fiscal, not monetary. The federal budget deficit is much too large, and the irresponsible OBBBA will pointlessly make it significantly larger. The Fed has a lot of power to determine exactly how the penalty for those budget deficits gets paid — elevated inflation, elevated interest rates, or some combination thereof — but the only way to reduce the penalty is to reduce the budget deficit, and that’s not something Powell, a replacement chair, or even the whole FOMC can do.

Very seriously,

Josh