ADRIAN MA, HOST:
There's continued speculation around whether President Donald Trump will try to fire the chair of the Federal Reserve, Jerome Powell. And while Trump has insulted Powell, calling him a, quote, "numbskull" with a, quote, "low IQ," he has not yet gone full "Apprentice" mode and told the Fed chairman, you're fired. But if Trump does, it would upend a decades-old tradition of independence between the Fed and the president. Here to explain how such a move could affect the economy is Carola Binder. She's an economic historian and professor at the University of Texas at Austin. Carola, thanks for being here.
CAROLA BINDER: Thanks for having me.
MA: The Federal Reserve System was created over a century ago. In those early decades, can you tell us what the relationship was between the president and the Fed?
BINDER: Sure. The Fed was created in 1913, so this was right before World War I. So when the Fed started off, it played a very subservient role to the Treasury because its responsibility was to help finance the war effort. So that meant that the Fed didn't have the kind of independence that it had today. Instead, it kept interest rates low to help with financing the war. And that relationship continued until 1951, when there was an accord between the Treasury and the Fed that gave the Fed substantially more independence for setting interest rates.
MA: Can you talk about why that happened? And how big a deal was it?
BINDER: Yeah. It happened because after the Fed helped the Treasury during World War I and World War II, they were expected to do the same thing during the Korean War. But keeping interest rates so low was proving to be inflationary. And there really wasn't any option to fight that inflation other than raising interest rates because the government had to keep spending to be able to finance the Korean War. Price controls were not as popular with the public as they had been during World War II, so monetary policy was really the only option left. And the Fed realized that they needed to be able to raise interest rates and to have some independence if they were going to have a chance at maintaining price stability.
MA: And since then, economists have sort of come to accept this as a norm of Fed independence. And this has not always sat well with presidents, has it?
BINDER: That's right. Central bank independence has become a worldwide norm as the best practice for macroeconomic policy. You have a central bank, and you delegate price stability to that central bank. But it's never been that popular with politicians because it takes a lot of control over the macroeconomy out of their hands. They would often like to have lower interest rates to make it easier to finance their spending and also to be able to boost the economy before an election. But when you have an independent central bank, that ability is limited.
MA: So by law, President Trump can't fire the Fed chair without cause. And if Trump did try to do that, Powell has reportedly said he would spend every last nickel fighting it in court.
BINDER: Yeah.
MA: How disruptive would this scenario be for the economy?
BINDER: Well, it would be disruptive because it would be such a break with precedent. As far as the Fed's policy, though, the important thing is that monetary policy is made by a committee. The FOMC members have overlapping and long terms. So even if Powell were to leave, there would still be a lot of continuity on the monetary policy committee. So that would be a good thing. That would mean that the new chair wouldn't be able to single-handedly decide a new course for monetary policy. But the signal there about this deterioration of the norm of central bank credibility - central bank independence - would be a big deal and would probably spook markets very much.
MA: And even if Trump does not attempt to fire Powell, he's already said when Powell's term is up next year, he would replace Powell with someone more in line with his low-interest-rate agenda. So in that scenario, would Trump be able to get what he wants with a more sort of aligned Fed chair?
BINDER: Well, the president has always had say over appointment of the Fed chair. So, yes, as long as he could get congressional approval, he could get someone who is more aligned with his policy views into that position. But again, you'd have that continuity with other committee members who've already been at the Fed, whose terms would continue. And that would put at least some guardrail on his ability to get the monetary policy that he wanted...
MA: Right.
BINDER: ...Because you would have to get the whole committee, or at least a majority of the committee, willing to cut interest rates substantially in order to get that policy.
MA: And there are 12 members of this committee, so just one person couldn't flip the whole situation by themselves.
BINDER: That's right.
MA: We've been talking with economic historian Carola Binder of the University of Texas at Austin. Carola, thanks so much for taking time today to break down this Fed chair-Trump situation with us.
BINDER: Thank you. Transcript provided by NPR, Copyright NPR.
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