Why the Damage to Fed Independence May Have Already Been Done

SPEAKER_2 (0:02)

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Tracy Alloway (0:18)

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.

Joe Weisenthal (0:22)

And I'm Joe Weisenthal.

Tracy Alloway (0:23)

Joe, you wrote a good newsletter this week.

Joe Weisenthal (0:25)

Thank you, thank you for saying that.

Tracy Alloway (0:27)

Just that one.

Joe Weisenthal (0:29)

I wrote a good newsletter this week. No, but interesting week, because obviously there's for months, talk about Fed independence, would President Trump try to fire Jerome Powell, all of these different questions. It's heating up. This is a very difficult topic to talk about podcast-wise because there's always that chance that we record something on Fed independence, and by the time the episode is produced and edited, something new has happened, so very dicey, but we're hoping that in the next short period of time, this holds. But yes, this is a really important story.

Tracy Alloway (1:03)

We're recording this on July 18th, and I think the ambition is to get it out on July 19th. Hopefully, nothing changes that quickly, but of course, you never know. Just this week, we have had these back and forth headlines.

We had a report that Trump was considering firing Powell sort of imminently, and then he came out at a press conference and said, no, he wasn't.

Joe Weisenthal (1:24)

Yeah, and he said there was a report that there was a literal letter that was signed. Other people affiliated in the administration have been hammering Powell, some unrelated to monetary policy, some relating to the cost of renovations of the Federal Reserve offices. The criticism is, of course, getting intense. Anyway, I've been trying to learn more about this question of Fed independence. I came across a lot of the research that was done by economist Carola Binder, which I thought was interesting, which talks about how Fed independence is this cherished idea in economics. But it's not just about the idea of whether the Fed is legally independent, pressure on the Fed itself, even if the Fed doesn't necessarily react, just the rhetoric against the Fed in central banks around the world, not the Fed specifically, but central banks around the world. Just the rhetoric and the pressure, the perception that the central bank is losing independence can have macroeconomic effects. Yeah.

Tracy Alloway (2:17)

And despite some people cherishing that independence, we know from a lot of recent events, the rise of populism around the world, that it seems a lot of people don't like unelected bureaucrats. Let's just put it that way. Okay. So we actually have Carola here. She is, of course, the Associate Professor of Economics in the School of Civil Leadership at UT Austin.

Joe Weisenthal (2:38)

Hook him, hook him.

Tracy Alloway (2:41)

Carola, thank you so much for coming on Odd Lots.

Carola Binder (2:44)

Yeah. Thanks so much for having me. Excited to be here.

Tracy Alloway (2:47)

Do you just want to give us maybe a summary of your previous work and why you got interested in the subject of central bank independence in the first place?

Carola Binder (2:56)

Sure. Yeah. I mean, the taper that was mentioned in the newsletter is one called political pressure on central banks. In that work, I really wanted to understand this distinction between legal central bank independence, which we know has been rising around the world for the past couple of decades versus actual or de facto central bank independence. Because it seems like even when the central bank does have legal protections that insulate the bank from politics, there's still always going to be reason for politicians to try to convince the central bank to do what they want. I mean, that's the whole reason why we have legal protections on central bank independence. So it's kind of hard to measure that. What I ended up doing with the help of a couple of research assistants was reading through these reports by Economist Intelligence Unit that come out every quarter for basically every country and just seeing whenever there was a mention of some kind of political pressure on the central bank and we tried to record whether it was pressure for easier or looser monetary policy and also whether the central bank resisted the pressure or succumbed to it. And then once we had this new data set about all of these instances, at least all the known instances of pressure on central banks, then I was able to use that to say, well, what happens afterwards, especially to inflation? And as Joe said, if the central bank succumbs to the pressure, it's almost always pressure for a looser monetary policy.

So that's certainly followed by higher inflation. But even if they try to resist, inflation still rises, just not as much, but it still rises. So my interpretation there is that it probably has something to do with expectations. So people start at least worrying that there's a chance that the central bank is gonna give in to those pressures. They know that if they do, that'll be inflationary. So inflation expectations rise right now, and that makes inflation itself start to rise also.