(Bloomberg View) — Research has documented that central banks around the world have been better able to control inflation if they enjoy independence from elected officials. The election of Donald Trump seems like a good time to remind ourselves that, historically, the executive branch has presented the greatest threat to the independence of the U.S. Federal Reserve.
Since its founding in 1913, the Fed has experienced two big failures of independence. The first occurred during World War II and its aftermath, when the central bank held long-term interest rates down to allow the government to borrow cheaply. Inflation soared to nearly 10 percent during the early days of the Korean War, until the arrangement ended with the so-called Fed-Treasury accord in 1951.
The second failure occurred in the latter half of the 1960s and the 1970s. Presidents Lyndon Johnson and Richard Nixon put (largely covert) pressure on Fed chairs William McChesney Martin and Arthur Burns to provide monetary stimulus to keep unemployment low and generate more popular support for their administrations. This led, in part, to the so-called Great Inflation of the 1960s and 1970s.
Could something similar happen today? Well, suppose Trump appoints a new Fed chair and vice-chair in 2018, replacing incumbents Janet Yellen and Stan Fischer. If he also fills two currently empty positions, he will have appointed four out of the seven members on the central bank’s Board of Governors.
Now imagine Trump decides that his new appointees should be loyal to him and his pro-growth agenda. He could put private (and possibly public) pressure on the Fed chair to ensure that monetary policy supported his administration’s plans, even if doing so led to high inflation. Presumably, he could also appoint a Fed chair sympathetic to his vision. (This would not be without precedent: Franklin Roosevelt and his Fed chair Marriner Eccles believed strongly in the need for congruence between the Fed’s monetary policy and the White House’s economic policy.)