Trump vs The Fed: Why central bank independence matters

The Justice Department investigation into Jerome Powell as chair of the US Federal Reserve has thrust the issue of central bank independence firmly into the media spotlight.

The investigation, announced in January 2026, was widely viewed as part of a plan aimed at replacing Powell with a chair who would be more amenable to Donald Trump’s desire for lower interest rates.

Powell himself warned: “This is about whether the Fed will be able to continue to set interest rates based on evidence and economic conditions; or whether instead, monetary policy will be directed by political pressure or intimidation.”

Following negative reactions – some from leading republicans – the nomination of an experienced central banker in Kevin Warsh, appears to have calmed the nerves.

Why is the independence of central banks so important?

In some monetary policy regimes with a low level of policy discretion, such as a fixed exchange rate regime, central bank independence may not matter.

However, the developed world moved from a fixed to a floating exchange rate regime after the collapse of the Bretton Woods arrangements in 1971. In the aftermath, without the constraint of defending a fixed exchange rate, price inflation became rampant.

Should politicians set monetary policy?

Part of the problem was that politicians were free to use monetary policy to gain short-term political advantage. Politicians have an incentive to exploit the timing differences which mean that cuts in interest rates can temporarily boost output at the cost of increases in inflation that come significantly later.

A well-timed pre-election stimulus can be difficult to unwind. Meanwhile, being forced to curb inflation (whatever the cause) can be unpopular with a majority of voters and businesses, as higher interest rates drive up the cost of loan and mortgage repayments.

After two decades of high, unstable inflation rates post-Bretton Woods, inflation target or similar regimes became the accepted norm to control inflation in developed countries with floating exchange rates.

But inflation targeting relies on the judgement of policymakers about inflationary pressures, which are highly uncertain. Given that level of discretion, albeit within a constraining framework, it became widely accepted that a politically neutral body is needed to ensure that interest rates are set appropriately to ensure price stability.

By generating credibility in the framework, a politically independent central bank with delegated responsibility for monetary policy and staffed by technical experts reduces the costs of inflation control, increases the economy’s resilience to shocks, and thereby helps to support sustainable real growth.

The degree of independence that central banks enjoy varies a great deal, as many academic studies show.

The European Central Bank (ECB) is arguably the most independent, having been delegated responsibility for price stability by an international treaty that is difficult to change. Yet even the Maastricht Treaty is open to interpretation, and the ECB has been subjected to legal challenges.

In the UK, the Government appoints the Governor of the Bank of England, the various Deputy Governors, the entire Board (known as the ‘Court’) and nearly all the members of each policy committee. No more than one internally appointed official serves on each.

The role of the Federal Reserve Bank

Many central banks have explicit mandates that also require them to support the government’s economic policies. For the ECB and the Bank of England, these are clearly expressed as secondary objectives.

The Fed has a mandate to promote: “maximum employment, stable prices, and moderate long-term interest rates.” This mandate persists, even though the Fed does not have the necessary powers (such as labour market legislation) to directly affect sustained levels of employment growth.

No public sector entity can (or should) be completely independent of government in a democracy. Governments make laws and can change them. Power may be delegated to independent bodies, but it can also be taken back.

Central banks are fiercely protective of their hard-won independence. However, in a direct confrontation with government, there can be only one winner.

There are certain unwritten rules concerning the independence of central banks. The credibility of monetary policy is enhanced, and the cost of inflationary control reduced, if governments do not criticise their central bank in public. In return, central bankers are supposed to avoid commenting on fiscal policy or any other political issues of the day, even if those policies make it harder to control inflation.

If central bankers speak out of turn, they run the risk that their independence will be curtailed and/or their appointments will not be renewed. Senior central bankers are aware of this bargain and behave accordingly.

As of October 2025, the International Monetary Fund (IMF) World Economic Database showed that 28 countries had inflation of more than 10 per cent.

Any country can suffer severe inflationary shocks and even central banks can make mistakes, as we saw in the post-pandemic inflation highs of 2022/23. But persistently high inflation rates seldom originate in a failure of monetary policy. They are nearly always the result of excessive fiscal deficits.

If a government cannot raise enough tax or cannot borrow enough to fund its spending plans, the ultimate resort is to print money and that almost always leads to uncontrolled inflation, no matter what the central bank might do to try to control it.

How independent are central banks?

Central banks have other responsibilities beyond monetary policy. These include maintaining resilient payment systems, issuing bank notes, and acting as the lender of last resort. They may also, to varying degrees, include financial stability and banking supervision. In developing countries, the responsibilities can go even wider.

A dutiful central bank will usually work to support its government in the national interest, to the extent that its powers or expertise can help and it does not compromise price stability. This is part of the implicit agreement that maintains their independence to set monetary policy. 

Politicised topics are more problematic. Many central banks recognise that climate change represents a material risk to monetary and financial stability and reflect that in their various policies.

However, if gross domestic product (GDP) or national energy policy depends heavily on fossil fuels, or if the owners of the industries responsible for the majority of carbon emissions also happen to be big political donors, then the central bank will find itself constrained.

Whatever the reason, if a country’s democratically elected leaders refuse to recognise the threats from climate change, then a central bank cannot publicly oppose that, even if it has a significant detrimental impact upon the central bank’s stability objectives.

Central banks have a unique degree of international discussion and coordination. The best-known example is the Basel Accord on banking supervision, which has no formal basis except that some form of it is signed into national law by many participating countries. Such international accords – and the global stability that they can bring – are being severely tested by increasingly nationalist regimes, notably by the US.

Populist and extreme politicians do not tolerate politically neutral public institutions; they see only supporters or opponents. Equally, they are likely to reject technical expertise because evidence-based analytical reasoning seldom suits their agendas.

The cost of White House intervention

This can come at a heavy cost in terms of economic stability. Every time the President of the United States criticises the Fed for not cutting interest rates, it stokes the fear of higher inflation. That can directly lead to higher long-term bond yields, and a weaker US dollar.

If the motivation for pressure on the Fed is to reduce the cost of financing the spiralling US sovereign debt mountain, cutting short-term interest rates is unlikely to be effective.

The US debt stock has an average maturity of under six years and one third matures within 12 months. Lower rates today will likely mean higher rates in future to control inflation. At best the sovereign debt crisis point might be delayed. Loose monetary policy has never been a cure for irresponsible fiscal policy.

Ultimately, the current threats to central bank independence are likely to be constrained by the same forces that created them in the first place: public abhorrence of inflation and bond market angst concerning unsustainable fiscal and monetary policy.

The spike in gilt yields following the unfunded tax cuts announced in the UK’s disastrous fiscal event in the autumn of 2022 should serve as a stark warning of what can happen. 

‘Experts’ may be seen as a source of societal ills by populist politicians, but giving independent central banks responsibility for controlling inflation is surely not the root cause of any current economic or political problem.

In the longer run, if incoherent macroeconomic policies cause economic chaos, that might well result in stronger central bank independence as part of the solution. For example, it would be a great improvement to have an independent appointments process for a central bank governor.

Unfortunately, these lessons may have to be learned the hard way. In the US, the Fed could be under intense pressure for some years to come. Financial markets and ultimately the US electorate will have to judge the consequences.

This article is adapted from a piece published in the February 2026 issue of Financial World, the magazine of LIBF, part of the Walbrook Institute.

Further reading

Should the Bank of England have a dual mandate?

Why would central banks want to issue digital currencies?

How big should the central bank balance sheet be?

Is the Monetary Policy Committee affected by groupthink?

Paul Fisher is an Honorary Professor at Warwick Business School and a former member of the Bank of England's Monetary Policy Committee. He teaches on the Global Central Banking and Financial Regulation qualifications.

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