Donald Trump Wants to Remake the Global Financial System

Mona Ali

In a quotidian sense, central bank independence refers to the ability of central bankers to make decisions regarding monetary policy without political interference. As Jerome Powell, chair of the Federal Reserve Board of Governors, likes to emphasize: Fed decisions are solely “data-driven.” Independence implies impartiality. A couple years ago, a member of the Fed’s board of governors earnestly explained to an audience of central banking experts that the Fed’s apolitical stance meant that “we don’t talk about politics; we don’t discuss politics.” The same Fed official then went on to emphasize the Fed’s “complete freedom of operation” in conducting monetary policy.

The first attribute (independence from politics) supposedly legitimizes the second (immense power). The Fed isn’t a democratic institution. It is an independent agency. Its board members aren’t elected officials and, in that sense, not accountable to the public. Governor Cook and her colleagues are presidential appointees confirmed by the US Senate. Their terms of service — fourteen years — are shorter only than those of federal and Supreme Court judges.

The Federal Reserve Act describes that the mandate of the board and the Federal Open Market Committee (FOMC, the body that decides the federal funds rate) is to make decisions to uphold the “long-run growth” of money and credit in ways that are aligned with the “long-run potential” of the macroeconomy — to advance maximum employment, price stability, and “moderate long-term interest rates.” The repetition of the phrase “long-run” may seem curious but in emphasizing the long-run horizon, Fed policymakers aim to send the message that they are not swayed by the electoral cycle.

But the Fed isn’t at all indifferent to [John Maynard] Keynes’s wisdom that, in the long term, we’re all dead: the FOMC is very much in the business of setting the short-term benchmark interest rate, which can shape the course of the short-term business cycle. Changes in the US policy rate impact borrowing rates across the world. Since the 2008 global financial crisis, the Fed’s board of governors has de facto become the central committee of the global financial system, putting out financial conflagrations through massive injections of dollar liquidity via its dollar swap lines and other facilities.

Formally, the Fed’s independence was consolidated in a 1951 settlement known as the Treasury-Federal Reserve Accord. This came about in the context of an overheated postwar economy and US entry into the bloody war in Korea. The US Department of Treasury favored lower interest rates to keep the costs of debt servicing down. This conflicted with the Fed’s desire to raise rates to dampen inflationary pressures. The tussle between the two agencies finally concluded in an agreement that the Fed was no longer required to maintain the interest rate ceiling on US government bonds. No longer was the Fed beholden to the fiscal agent of the administration.

Consistent with Milton Friedman’s flawed precept that inflation is “always and everywhere a monetary phenomenon,” and hence manipulable through changes in the money supply, inflation targeting (to anchor long-term inflation expectations) became the touchstone principle of central bank independence everywhere from New Zealand to the United Kingdom — although famously not in Japan, which still engages in yield curve control. This means that in the context of a low-growth economy, the Bank of Japan intervenes in bond markets to shape interest rates on government bonds of varying maturities. This encourages inflation while also stabilizing large portfolios holding government debt.

The Fed and other major central banks have often failed in their attempts at inflation targeting. For years leading up to the inflationary shock of 2022, actual inflation in the US economy consistently hit below the Fed’s inflation target and as Jerome Powell recently pointed out in his Jackson Hole speech, over the last four years, inflation has persisted above the Fed’s target. (That this has occurred despite the Fed’s attempts at fine-tuning monetary policy — through its repo facilities, which regulate Treasury bond yields and liquidity, points to the multifaceted nature of inflation.) Unlike the ECB [European Central Bank], which does not have employment in its central banking mandate, the Fed must balance tamping down inflation with its potentially negative impact on US employment.

In practice, central bank independence means that the Fed does not directly purchase new Treasury securities from the US Treasury. It only purchases government bonds in the secondary market, once they have already been auctioned off in the primary market, where leading financial institutions, known as primary dealers, are expected to absorb new government debt issuance.

When it comes to setting interest rates through the buying and selling of government bonds, the Fed interfaces with this set of dealers whom it has designated as its counterparty in open market operations to maintain its monetary policy stance. These twenty-five entities are either independent broker-dealers or broker-dealer arms of banks that are classified as “globally systemically important.” (Of the fourteen G-SIBs on the primary dealer list, eight are foreign-owned.) In a democracy, this arrangement looks a little bit like an imperial court. And in a globalized financial system that runs on Treasury collateral, codependence between the central bank and the big players in the financial sector has only grown.

While the US central bank nominally gained independence from the government, there is day-to-day coordination between the Fed and the Treasury to ensure that there is enough liquidity in the Treasury market, that payments between Federal Reserve banks clear, and that newly issued Treasuries are successfully auctioned. Fiscal and monetary policy are therefore inherently connected. Fiscal spending has monetary outcomes: a system-wide increase in bank reserves. The lines between fiscal and monetary policy became blurred during the global financial crisis and again during the COVID crisis as the Fed engaged in quantitative easing, buying loads of government bonds and other securities.