The Fed’s New Framework is a series of reflections on where Fed policy is going by looking at what a number of others have said, namely, Claudia Sahm (1), Robin Brooks, Victor Constancio, Scott Sumner, David Beckworth, Veronique De Rugy and Claudia Sahm (2) , David Beckworth (2)
The Fed’s New Framework -1 looked at Claudia Sahm, FNF -2 at Robin Brooks and Victor Constancio, in FNF -3, it was David Beckworth. FNF-4 was Scott Sumner. I now turn to the Libertarian perspective of Veronique de Rugy, “The Illusion of Fed Independence.”
In criticizing those who facilely defend Fed “independence” from Trump’s criticisms, De Rugy employs a distinction between operational” independence -- “the ability to set interest rates and conduct monetary policy without daily interference from the White House or Treasury” -- and economic” independence.
Operational independence is entirely conventional and is enjoyed by virtually all central banks, not just the Fed. What de Rugy calls “economic independence”
for fiscal policy -- the borrowing and spending choices of Congress and the president – [NOT] to shape the Fed’s room to maneuver
is not an “illusion” but an impossibility for a central bank with a mandate to manage macroeconomic outcomes.
The Fed in choosing the levels and movements of the policy instruments that, it in its independent judgment serve to achieve its Congressional mandate of maximum employment and stable prices, must maneuver around fiscal (or non-fiscal) policy.
a) The greater the fiscal deficit, ceteris paribus, the higher interest rates need to be to kept aggregate demand from exceeding the level intended to achieve the chosen inflation target.
b) Deportations or tariff increases may create supply shocks that require lower interest rates to temporarily inflate at above target rates.
Neither conventional operational nor impossible economic independence, however, address the actual issue of political independence:
Insulation from short-term partisan manipulation, and the dangers that come from presidents leaning on the Fed to juice the economy before an election, as Nixon did in the 1970s and as Trump has done more recently.[1] In practice, “political independence” is less about being beyond politics and more about maintaining a norm of restraint.[2]
But this:
…for all the outrage we are hearing from everyone on what is happening with Trump and the Fed at present, very few people were bothered when Chairman Powell was urging Biden and Congress to pass lots of stimulus and Covid rescue bills during the pandemic”
borders on “whataboutism.”
Any given Fed comment on fiscal policy -- generally in response to a question from Congress and usually just pointing out the obvious -- may be undesirable, but desirable or not, it’s quite a different kettle of fish from a President opining on Fed policy.
And it’ did not start with Powell:
1960s – William McChesney Martin
- warned publicly against excessive fiscal stimulus during the Vietnam War and Great Society programs, fearing inflation.
1970s – Arthur Burns:
- argued that Congress’s unwillingness to restrain deficits made it harder fir the Fed to fight inflation.
1980s – Paul Volcker:
- testified that Reagan’s large deficits made interest rates higher than they otherwise would be, complicating the Fed’s fight against inflation.
1990s – Alan Greenspan
- supported deficit reduction, aligning with Clinton’s 1993 budget but also endorsed Bush’s tax cuts.”
2000s – Ben Bernanke
- during the Global Financial Crisis (2008–09), consistently urged Congress to adopt fiscal stimulus alongside Fed actions.
2010s – Janet Yellen
- stated that fiscal austerity after 2010 slowed the recovery, leaving the Fed to carry.
Finally, political interference is not the same as “fiscal dominance” e Rugy raises by:
Fiscal dominance [can occur] in the name of fiscal sustainability. Some economists, including me, have wondered whether there was more to the Fed's hesitation to raise interest rates when inflation took off in 2021 than a misread of a situation it called "transitory."[3] The motivation for fiscal dominance was there. Then and now, higher interest rates mean higher interest payments, more borrowing and a higher deficit.
As University of Virginia economist Eric Leeper recently wrote, for the first time ever, the president is now making the connection explicit. Trump is demanding lower rates on the grounds that high interest payments on government debt are "costing taxpayers trillions." That's the textbook logic of fiscal dominance, and a return to the pre-1951 thinking.
No, “motivation for” and “textbook logic of” are not real fiscal dominance. As explained in FNF-4,
fiscal dominance, unlike political interference, is not something a central bank can accept or reject. Fiscal dominance is the state at which a fiscal deficit makes it impossible for a central bank to set an interest rate (or vector of its policy instruments) to achieve full resource employment without that rate itself reducing resource employment, the point at which an “inflation tax” becomes optimal.
De Rugy is, however, correct to warn that the US has moved toward that state, saying
Interest payments already loom large, and the temptation to lean on the Fed is strong, as we see with Trump. Sadly, the temptation will not only persist after Trump leaves office, but it will intensify as our fiscal problems worsen.
That’s the long-term risk to Fed independence: not just presidential tweets or phone calls, but the quiet structural drift toward fiscal dominance.
Oddly, de Rugy did not even mention the underlying impetus toward fiscal dominance, the deficits. Nevertheless, the deficits themselves, not the Fed’s inability to prevent them from producing excessive inflation, would be the catastrophe.
Meanwhile, back in 2025, the issue of political interference is very much alive. And neither de Rugy nor anyone else so far has directly addressed how the Fed’s New Framework may help or hinder preservation of its political independence.
All the more reason to be alert for the next installment of “The Fed’s New Framework.”
_________________________________________________________
Image prompt: “A central banker cowering beneath a suspended weight labeled “Fiscal Dominance”
[Standard bleg: Although my style is know-it-all-ism, I do not really think that, knowing that I can be mistaken or overstate my points. I’m also aware of an amazing range of views and experiences among readers. Bring those to bear by commenting on these posts. Both other readers and I will benefit.]
[1] Presumably de Rugy referrers to the summer of 2019, but many observers, not just Trump, thought that rates should have been reduced. Even though Trump’s attempt to interfere was objectionable, the Fed’s action was probably NOT a case of it acting against its judgment.
[2] Which has nothing to do with de Rugy’s jejune observation, “The Fed has never been outside politics. Governors are nominated by the president and confirmed by the Senate; Congress defines the bank’s legal mandate through the Federal Reserve Act. These are the channels of political accountability.”
[3] Or, more likely, a very intentional engineering of over-target, (and greater than “make up”) inflation to reduce the unemployment of resources caused by sectoral shocks.
Do you agree with the Fed lowering rates? I generally agree with Friedman that the Fed should target price stability because the Phillips curve only holds in the short run (it probably doesn't even hold in the short run anymore). But these are exceptional circumstances, and I think inflation is a lesser evil than unemployment.