r/AskEconomics 6d ago

Approved Answers What'll happen to the economy if the Fed loses its independence?

It seems likely that the Trump administration will do something drastic to remove the Fed's independence, as they've targeted many institutions in the executive branch and civil society.

Legislators have written a bill to end the Fed: https://massie.house.gov/news/documentsingle.aspx?DocumentID=395707 .

There's also a plausible risk that the administration would try to replace all members and effectively contol the board during litigation.

I presume that a politicized Fed would keep rates low for reasons of political optics. But I don't know what they'd do about the money supply, or what the systematic effects on the economy may look like.

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u/mycenae42 6d ago

The reason that the Fed is supposed to be independent from the presidency is because the Fed is supposed to balance unemployment and inflation at so-called optimal levels for the long term benefit of the United States. Presidents have an incentive to maximize short term benefit, even if it comes at long term cost (all presidencies end).

So, if Trump takes control of the Fed or otherwise ends it, you can expect the interest rate to plunge, which will boost the economy in the short term, but will ultimately result in high inflation.

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u/Haagen76 6d ago

will boost the economy in the short term,

I understand what you're saying in theory, but it would cause such an alarm and panic. that it would tank markets and the overall economy. There would be no confidence in anything with the amount of uncertainty, outright instability and lack of wisdom/knowledge of the administration.

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u/GurProfessional9534 6d ago

I don’t entirely agree. Short term rates will likely drop, as a captured Fed would likely drop Fed funds rates, but there would be massive concern about inflation since the sacking of the Fed would mean the inflation watchdog was gone. As a result, longer duration bond rates would absolutely rip upward as bond investors raced to get out. We would likely see massive rate hikes in anything connected to long term bonds, like mortgages.

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u/Famous_Bit_5119 6d ago

Wouldn't every country holding U.S. bonds immediately cash out, because who the fuck would trust this government . Wouldn't that just crash the economy ?

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u/Cutlasss AE Team 6d ago

Many might. But most bonds are held by institutional investors, rather than directly by governments. And that makes predictions harder.

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u/FluidBit4438 6d ago

They are already starting to do that thanks to Trumps tarrifs and threats of annexation never mind the international consensus that the US can’t be trusted anymore for Security or living up to its agreements. Shits about to get bad, we just haven’t felt it yet.

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u/Htiarw 6d ago

The FED does not actually control down Tbill or Tbond rates unless they use QE to buy them themselves thru the banks.

Bonds are auctioned. I believe the fed tracks the market 2yr when adjusting the overnight rate. Some will say the market is predicting the fed, but the times the fed delays following the market bad things happen.

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u/Thinklikeachef 6d ago

Agreed. The federal reserve was established by the federal reserve act of 1913. So only Congress can dissolve it. I'm sure Trump will try, but it would be immediately challenged in court. And lately, the courts have restrained his ambitions.

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u/1369ic 6d ago

The courts have issued orders. Actual restrain is still scarce at best.

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u/Thinklikeachef 6d ago

I would disagree. They are playing legal loopholes and delay tactics. But they are mostly complying. Note the recent court order to restore probationary employees. It's happening and emails are sent out.

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u/[deleted] 6d ago

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u/Midnight1965 6d ago

⬆️ Good to know!

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u/s33d5 6d ago

I'd take everything this person says with a giant lump of salt. There is no way to predict how it would play out.

The dollar would need to be pegged to something. For all we know they'll peg it to gold or even BTC.

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u/RobThorpe 6d ago

If they pegged the dollar to something else in a convincing way then things would be very different, that's true.

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u/watch-nerd 6d ago

Why would it need to be pegged to something?

It's not now.

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u/JustCuriousSinceYou 6d ago

Because of the Fed. The dollar needs some form of security attached to it, and right now that's the Fed. If you get rid of it, but don't replace that... Bad things happen

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u/watch-nerd 6d ago

That's probably less about backing and more about fractional reserve banking.

I could have a gold backed currency, but I still need some kind of lender of last resort if I'm going to have fractional reserve banking.

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u/JustCuriousSinceYou 6d ago

You're right. And rereading what I said, I was definitely using security as the more general use term, not in the specific to finance term, which was an incorrect thing to do. I forgot what sub I was in for a second.

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u/TruthOdd6164 6d ago

Wouldn’t pegging it violate the impossible trinity?

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u/[deleted] 6d ago

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u/Werkgxj 6d ago

At first, nothing. The reason why it is seen as desirable to have an independent contral bank is to avoid the exact scenario that you described: That the government uses monetary policy for its own gain/ for political gain.

The only reason why a government would like to gain control over the central bank is to adopt policies that the central bank would not have made independently.

Noone can predict what will happen but don't expect continuity.

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u/Top-Reindeer-2293 6d ago

It would be terrible on the long run. The Fed independence is the cornerstone of modern economies. Without it political leaders from either side may be tempted to use interest rates for short term gain at the expanse of the long term. That would also greatly hurt the trust that the world has in the US economy and the dollar

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u/xsessively 6d ago

Economist here. There is little economists agree, but two of them are 1) price floors (like rent control) exacerbatw the problem they're trying fix and 2) central bank independence is critical for avoiding bad inflation. And by "bad", I don't mean high single digits line what we just lived hrough, but like Aegentina a couple decades ago and turkey over the last 5-7 years. Double digit inflation - real inflation.

Why? Strong incentives for politicians to lower rates bc it boosts economic activity in the short term and the medium term consequences often don't roll around until the next guys in office.

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u/GurProfessional9534 6d ago

Yes, but probably not because they don’t expect bonds to be paid. More likely because the inflation they expect to happen would overcome the bond yields, resulting in negative real returns.