The Fed and Inflation and Lisa Cook:

Central Banks, Fed Independence, and Trump's Announcement to Fire Lisa Cook

Just a handful of books about central banking kicking around my messy office

I had already been planning to write this week’s newsletter about the Federal Reserve, the notion of central bank independence, and the personality clashes that are coming ever faster and more furious with the Trump administration, and then I saw that Trump had announced that he was firing Lisa Cook, a historic appointment by the Biden Administration to the Federal Reserve’s Board of Governors. This is an unfolding news story, Lisa Cook and her lawyer have expressed their plan to fight back, and it’s also of a piece with how the Trump administration has been systematically dismantling the types of appointments that straddle presidential administrations in an attempt to check presidential powers. So first a little background on what the Fed does, how and why the Fed is supposed to be insulated from politics, and why Trump is particularly livid about this current Fed administration. And more to come on all of this, because there’s a lot more than 1000 words to write about everything.

Central banks are institutions that have been around for centuries. The world’s oldest central bank is Sweden’s, aka the Sveriges Riksbank. Most central banks in their earliest forms emerged as private banks that helped finance ruling monarchy’s spending. (In Swedish, riks means ‘realm’.) The precursor to the Riksbank was the Stockholms Banco, founded in 1656 and run privately by Johan Palmstruch; his bank ultimately failed (issued too many notes without enough collateral). Though Palmstruch was initially condemned to death, he was eventually granted clemency, and tasked with the responsibility of creating the Riksbank in 1668 under the auspices of the Swedish parliament. In time, these banks transformed into banks for banks; for example, JP Morgan Chase played an integral role in resolving various banking panics at the end of the nineteenth century and start of the 20^th century. Different factions in the US historically opposed creating a central bank, and stymied nineteenth century efforts to create them, and it was not until the early 20^th century that JP Morgan and a cadre of political officials were able to broker the creation of the Federal Reserve System, more or less as we know it today.

I tend to use the term ‘monetary authority’ interchangeably with ‘central bank’. How central banks are structured differs slightly country-to-country (some are called central banks like the Bank of England or Bank of Mexico, others are federal reserve banks, like in the US and Australia, Singapore’s central bank is the Monetary Authority of Singapore, etc), but in essence, these institutions are charged with deciding how much money should circulate and targeting the interest rates that will shape the interest rate decisions that private banks make[1]. These decisions are important; they generally make it easier or harder (less or more expensive) to borrow money, which in turn is assumed to influence all kinds of economic activity that may ultimately affect (1) the aggregate price level and (2) the employment rate in a given economy. Whether and how central banks make decisions about inflation and the employment rate is determined by their mandates: some banks, like the European Central Bank, have single mandates to target inflation; others, like the Federal Reserve in the US, have dual mandates, to both stabilize inflation rates and promote full employment. These mandates are very important because they shape the likelihood that central banks will make things easier or harder for firms to expand business, which should, we hope, have knock-on effects for employment, particularly if a given economy is stuck in an extended recession.

An important feature of most modern central banks is the assumption of their ‘independence’, meaning their existence outside of direct government control. The logic behind this is the belief that something called a ‘political business cycle’ exists: according to the theory of the political business cycle, governments have incentives to pursue policies that are likely to get them re-elected, like cutting taxes, increasing spending, and similar, and to ignore the potential that these policies have to create adverse effects, like inflation and higher interest rates down the line on government debt[2]. The point of keeping a central bank independent is so that the figures responsible for keeping inflation rates in check by, say, raising interest rates, aren’t vulnerable to being voted out by angry voters. The way that this independence has traditionally been maintained in the Fed’s case has been by staggering the appointment of the Federal Reserve Chair out of sync with the election of a given presidential administration. So, when Trump came into office back in 2016, he was stuck with then Fed Chair Janet Yellen until November 2017, when the Senate confirmed Jerome Powell the first time. Biden opted to nominate Powell for the Fed Chair during his term, and now Trump has been threatening to fire Powell since coming back into office in January 2025.

Why has Trump been threatening to fire Powell? Well, it comes back to those Fed decisions. During recent economic crises, namely the Global Financial Crisis of 2008 and the COVID-19 Pandemic, the Federal Reserve in the US responded by cutting interest rates close to zero. More in future posts on the consequences of those cuts, but they created a very conducive environment for businesses (and households) to borrow, and for a host of reasons, there was more economic activity (read: borrowing and spending) in the wake of the 2020 rate cuts than there were back in 2009 and 2010. As inflation rates rose in 2021 and 2022, the Federal Reserve followed the trend of many central banks around the world, and began to hike (raise) interest rates starting in March 2022, and continued doing so through June 2023. This rapid and consistent raising of rates cooled borrowing for a number of capital intensive industries, among them home building and wind generation, and also chilled home buying. Inflation rates gradually fell[3], and by September 2024, the Fed planned another rate cut, given what many analysts characterized as a ‘soft’ landing – inflation rates had fallen, employment trends were still strong, and the economy seemed, fingers crossed, to have come through.

Since Trump has come back into office, the Fed has maintained that it’s waiting to see what tariffs do to inflation before it continues that trajectory of cutting rates. And since Trump has come into office, he’s been pressuring the Fed to cut rates. And, despite Powell’s announcement at the annual Jackson Hole conference that the Fed will cut rates in September, Trump is trying to ratchet up pressure for the Fed by firing members of the Board of Governors (the seven members, including the Fed chair, who serve staggered 14 year terms, and are nominated by the President and approved by the Senate), in order to replace them with his own appointments. This is what Fed independence is explicitly designed to protect against. What happens next is up in the air – Lisa Cook and her lawyer are going to fight against this, while the administration will presumably continue to bring pressure against the Fed in an unprecedented manner. I’m staying tuned, and will be continuing to write about the Fed and inflation in the weeks to come.

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[1] There are quite a few other policy tools that central banks have at their disposal, to be detailed in later newsletters, and a few more responsibilities, too, also to be described at greater length later on.

[2] I promise to talk in more detail about this – including whether and when it’s likely to be a problem – in newsletters down the line! But the quick and dirty explanation of this is, in the case of inflation, the potential for policies that increase spending to push that aggregate demand curve rightward, all else equal, pushing producers past their productive capacity, and encouraging them to produce more despite rising costs, and resulting in inflation for everyone. In the case of rising interest rates, it has to do with bondholders’ fears of a government defaulting on its debt, and demanding higher interest rates in exchange for purchasing that debt. Whether that applies to a given economy depends on many more factors than just the fiscal deficit in a given year.

[3] Did inflation rates fall because of those rate hikes? It’s contentious, and worth a newsletter of its own!