Who Needs to Replace Powell? Politicians Are Already Doing the Fed’s Job

In a Truth Social post ahead of the Federal Reserve’s rate-setting meeting on Wednesday, President Donald Trump urged that the Fed “must now lower the rate.” (Chip Somodevilla/Getty Images)

About the author: Eric M. Leeper is the Paul Goodloe McIntire professor of economics at the University of Virginia and a distinguished visiting scholar with the Mercatus Center at George Mason University. He is writing a book about the fiscal foundations of inflation.

For all the discussion of President Donald Trump’s battle with Federal Reserve Chair Jerome Powell, a new master is already in place. Welcome, America, to the age of fiscal dominance.

For the first time, a president has rhetorically linked the Fed’s interest-rate-setting function to fiscal policy. Trump routinely says Powell’s rates are “costing the taxpayer” trillions of dollars in interest payments on the federal debt. He demands the Fed bow to fiscal policy and keep rates low so that the government can borrow more cheaply.

But when the government pays for its borrowing costs with more borrowing, inflation is left at the mercy of the politicians who set federal taxes and make spending decisions. This runs counter to an arrangement Americans know and love: Congress controls debt, the Fed handles inflation.

Interest payments on government debt already consumed 17% of federal spending when Congress passed the “Big, Beautiful Bill” earlier this month. The Congressional Budget Office projects the legislation will generate an additional $4 trillion in debt over 10 years, $600 billion of which are interest payments. When interest costs were last this high, in the early 1980s, Congress and the president subjugated fiscal policy. They raised taxes and cut spending. Today, Congress’s only plan to pay back the debt is to keep borrowing.

At the same time, Trump is auditioning replacements for Powell nearly a year before his mandate is up. He is only considering candidates who will almost certainly cut rates. Presidential-Fed drama isn’t new. But taken together, these Washington power games signal a fundamental shift to fiscal dominance.

It creates an environment where the traditional inflation-fighting tool— higher interest rates—can over time become inflationary itself. Higher rates raise interest-payment costs, which are then financed with more borrowing. Without the offset of higher taxes or lower spending, the debt grows. More money is pumped into the economy in the form of Treasury securities. On net, the public receives more income. And so the higher rates eventually become a form of stimulus, driving up demand and prices.

We have seen the inflationary effect of fiscal dominance before. From the Banking Act of 1933, which established the Fed’s ability to buy and sell government debt, until the 1951 Treasury-Fed Accord, the Fed’s primary mission was to keep U.S. Treasury borrowing costs low, much like Trump wants. During that period, inflation chaotically bounced between 8% and -1%.

In the 1970s, the Fed favored economic growth over inflation control. Prices rose from less than 3% in the mid-1960s to more than 13% by 1980.

The last time interest payments on the federal debt were comparable to today’s, it was because Fed Chair Paul Volcker was fighting the inflation of the 1970s with double-digit interest rates. But there are some important differences between then and now. In 1982, an interest-rate increase meant higher payments on a debt stock of 35% of gross domestic product. Today, the same rate increase applies to debt equaling 121% of GDP—more than triple the fiscal impact.

Volcker understood the effect of high rates. He called out Congress for running chronic deficits, telling a Senate committee in 1979 that the U.S. needed “a sustained, disciplined fiscal policy.” In a game of chicken, it was Congress and President Ronald Reagan who flinched. Reagan’s signature 1981 tax cut was promptly followed by “revenue enhancements” that signaled a return to business as usual: deficits corrected by surpluses.

Presidents commonly complain about Fed policy. Everyone wants low rates, especially going into an election. Historically, disagreements were about weighing inflation versus unemployment and were mostly expressed privately. Complaints are now aired repeatedly and publicly through a coordinated, multipronged messaging campaign, in which Trump and his surrogates claim on live television that the Fed is taking money out of Americans’ pockets.

Trump essentially wants a new Fed mandate—debt stabilization.

The Fed’s existing mandate precludes that, however. The Federal Reserve Act tells the Fed to control inflation, which by nature destabilizes debt. The Act is mum about debt stabilization, leaving that task to Congress through budgetary decisions. Demanding Powell do all of the above is to demand the impossible.

Congress faces a choice. It can change the Fed’s mandate or behave like most congresses over the past century and ensure the soundness of an American crown jewel—Treasury securities. What is it going to be? Fiscal discipline or endless inflation?

Guest commentaries like this one are written by authors outside the Barron’s newsroom. They reflect the perspective and opinions of the authors. Submit feedback and commentary pitches to ideas@barrons.com.