The purpose of this article is to highlight the possibility of favorable effects of the US President Donald Trump’s expected intervention in the US Central Bank, Federal Reserve (Fed), on central banks across the world. Its background is as follows.
- Donald Trump at his political campaign for the US Presidency effective from 20 January 2025 made a promise to establish the Department of the Government Efficiency (DOGE) co-headed by Elon Musk and Vivek Ramaswamy.
- The promised mandate of the DOGE was to audit federal agencies, cut wasteful spending and reduce fiscal spending by about US$ 2 trillion to cut the fiscal deficit.
- The other objective of the DOGE is to cut the deep federal bureaucracy in order to further promote the market-based economy.
- Accordingly, the DOGE has commenced a swing of examining of spending of federal agencies and detected a large number of unproductive spending. As the first step, the DOGE team has got the access to the Treasury Payment System to audit payments on line items in the time series.
- As the next step, the DOGE team has already entered the USAID, Internal Revenue Service (Tax Department), Social Security Payment System and Pentagon and revealed a missive scale of wasteful and corruptive spending. The fundamental question raised on all questionable payments and spending is what is the benefit to tax payers.
- The suspension of the USAID on allegation of corruption and criminal type conduct and US contributions to various global organizations such as WHO and NATO has already been felt on the global community ranging from the poor to political leaders and governments due to blockage of US dollar flows across the world.
- The news is now available that the DOGE team is to visit the Fed to audit its payments and spending in the context of examining the Fed’s efficiency in serving the tax payers (Watch media news) ((Comments by Ramaswamy). The rumors are spreading that the Trump Administration is planning to amend Fed’s objectives and certain functions so that the President can intervene in the Fed’s key policy decisions such as policy interest rates at times of national interest.
Policy conflict between Donald Trump and Fed
It arose at the beginning of his first term in January 2017 consequent to the Fed keeping its interest rate (Target for the Federal Funds Rate) at 0-0.25% from December 2008 for the most period of the President Barack Obama Administration (see the two Charts below). This was the monetary policy followed for about a decade to resolve the global financial crisis 2008/09.
However, the Fed commenced hiking interest rates since December 2015 under the Chair of Janet Yellen where it stood at 0.50%-0.75% when Donald Trump assumed the Administration in January 2017. Therefore, he started publicly quarrelling for zero interest rates that were given to Obama Administration. As a result, he did not extend the term of Janet Yellen in February 2018 and appointed the present Chairman Jerome Powel who was in the the Board of Governors since 2012. His current term of office as the Fed Chairman is to end in May 2026 where his term of office as a Fed Governor is to end in January 2028.
- However, soon after the Fed Chair appointment, the Fed accelerated the rate hikes by 0.25 at each of seven consecutive meetings from March 2017 to 2.25%-2.50% level in December 2018 in speculation of possible rise in inflation in the near-term although inflation in fact was around the target of 2%. This fueled the President Trump’s agitation over the Fed’s rapid monetary tightening.
- The Fed’s motive for tightening was to unwind the money printing of nearly US$ 4 trillion carried out to inject fresh liquidity to fight the global financial crisis 2007/09 before it becomes inflationary. Therefore, the President commented that he knew inflation better than the Fed and searched legal provisions to remove Jerome Powell from the post of Fed Chairman.
- However, this policy conflict disappeared as the Fed re-introduced an ultra-loose monetary policy without any delay to deal with the Covid pandemic beginning March 2020 as the Fed cut interest rates back to 0-0.25% and raised money printing further by about US$ 3 trillions or 72% by June 2020.
- Later, the Fed Chairman accepted that the rate hiking cycle in 2017/18 was a policy mistake. In fact, the Fed cut interest rates in 2019 by 0.75 to 1.50%-1.75% level as the US economy as well as the global economy started to slow down, partly due to the Fed’s rapid monetary tightening.
- The present conflict arose when the Fed kept policy interest rates unchanged at 4.25%-4.50% level at the last meeting held on 29 January 2025 (9 days after Donald Trump took oath as the President for the second term) after three consecutive rate cuts of 1% in total in three months, September to December 2024, where the President advised the Fed to continue the rate cutting cycle. Therefore, the President immediately after the Fed’s latest policy decision commented that he knew interest rates better than the Fed.
Fed Interest Rate Trend
US Inflation Trend
Current developments on the Fed at the Senate and Congress
The half-yearly testimonies of the Fed Chairman before the Senate Banking Committee and House Financial Services Committee took place on 11 February and 12 February 2025, respectively (Senate Testimony) (Congress Testimony). Accordingly, several answers given by the Fed Chairman to Committee members have now fueled the fire over the Fed’s inefficiency and poor accountability over its mandate. Therefore, there is no doubt that the President Trump and Elon Musk will use them to question operational inefficiency of the Fed and its value to tax payers. Some of answers are highlighted below to shed light on the Fed’s policy inefficiency in general.
1. Accountability of bank regulation
A question was raised as to what action had been taken against Fed officials over the failure of several banks including Silicon Valley Bank (6th largest US bank) in March 2023. The Fed as well as other bank regulators had publicly accepted their failure.
The Fed Chairman responded that there was no failure on the part of Fed officials as it was the fault of regulatory playbook used by the Fed to regulate banks. Accordingly, as officers had followed the playbook, they could not be held accountable for the failure of banks.
The Fed Chairman stated that the playbook covered areas like bank governance but did not cover banking risks such as liquidity risk and interest rate risk on long-term securities portfolio and funding. He added that the playbook is now amended to cover such risk for supervision.
This is a highly irresponsible and strange answer because the DNA of bank supervision is to ensure sound management on liquidity and interest rate risks in banking books as banking business is nothing but management of these core risks. Even bank governance systems have evolved to bear the accountability over management of such risks. Further, the Fed as well as all global bank regulators learned lessons from the global financial crisis 2007/09 on the importance of managing liquidity risk and interest rate risk among other risks.
What both the Fed Chairman and Parlimentarians did not understand is the fact that the inappropriate playbook or operational system is the fault of the officials and the Board. Therefore, those who followed inappropriate playbooks should be held accountable for the crises or failures.
Therefore, this answer exposed the Fed’s inefficiency in bank supervision.
2. Inability of the monetary policy to control long-term interest rates
In an answer to a query over the Fed’s monetary policy transmission, the Fed Chairman stated that the Fed monetary policy worked through short-term interest rates as long-term interest rates were dependent on factors outside the Fed control such as various macroeconomic and market factors, i.e., federal deficit and debt, growth and long-term inflation expectations that affect the term premium.
However, the general belief over the monetary policy world-wide is that the monetary policy affects all layers of interest rates with varying time lags and transmits policy effects on aggregate demand and prices through interest rates and credit flows.
The member then questioned whether there was a purpose of the monetary policy if the Fed could not control all interest rates. In response, the Fed Chairman stated that the target of short-term interest rates was the policy framework pursued by the Fed. This answer is quite similar to the answer on the bank supervision playbook stated above.
Therefore, this answer exposed the inefficiency of the Fed’s monetary policy. It is obvious that the Fed just follows the monetary policy in theory as it believes on office files without knowing exact conduits and outcomes in the real world.
3. Ultra loose monetary policy in response to the Covid pandemic
The Fed operated an ultra loose cycle of monetary policy since March 2020 in response to the global Covid pandemic. Accordingly, the Fed cut its interest rate to 0-0.25% in March 2020 from the level of 1.50%-1.75% in February 2020. In addition, the Fed ballooned its balance sheet by US$ 4.8 trillion to US$ 8.9 trillion at the end of April 2022 from US$ 4.2 trillion that prevailed at the end of 2019. This is an increase of money printing by about 114% (see the Chart below for the Fed’s money printing trend since 2008).
When the media raised concerns over possible inflationary pressures near-term, given the historic contraction of the supply side by the Covid pandemic, the Fed Chairman responded that the Fed was not acting on the inflation hypothesis at this time of humanitarian crisis. He maintained that the Fed’s objective of the ultra loose monetary policy and injection of fresh liquidity in such a massive scale was intended to keep the financial system stability in anticipation of a liquidity crunch that could be triggered by the Covid crisis in the event the public may liquidate their financial wealth into money to face the pandemic impact on businesses and living standards.
4. Delayed monetary policy to control post-Covid inflationary pressures
Until March 2022, the Fed declined to commence the monetary policy tightening cycle even if inflationary pressures were visible from March 2021 well beyond the 2% target used in the monetary policy. When the Fed commenced hiking its interest rate by 0.25 in March 2022, inflation had reached four-decade high 8.5%.
The reason for the Fed to delay the monetary tightening was the Fed’s firm belief that the inflation at this time was transitory on account of disruptions of supply chains affected by the Covid pandemic. Therefore, the Fed maintained that inflationary pressures would be short-lived and diffused when supply chains gradually resume towards normalcy. The policy belief and response were same for the Bank of England and European Central Bank too.
When Parliamentary Committee members questioned the delay to act promptly to arrest inflationary pressures, the Fed Chairman responded that not only the Fed but also all standard economists held the same view of transitory inflation and, therefore, the Fed did not act early.
However, central banks cannot fall behind views of others to act on their policies as the responsibility, discretion and information are only available with central banks. It was the common monetary sense to detect early warnings of inflationary pressures and act early, given the historic scale of money printing and zero bound interest rates that prevailed since March 2020 towards the end of 2021. Therefore, the Fed’s timing, path and efficiency in its post-Covid monetary policy are highly questionable as usual.
5. Fed’s ability to carry on both monetary policy and bank supervision
In response to a query whether the Fed is able to carry on both monetary policy and bank supervision together, he answered affirmative. He stated that when the Covid crisis hit in March 2020, Fed officers had the knowledge on what to do. Therefore, the Fed could introduce a liquidity injection framework across all markets without any delay.
However, what the Fed did was the re-implementation of the same liquidity injection instruments that were operated for the global financial crisis 2007/09. However, the Covid pandemic was a health crisis and not a liquidity crisis in markets. Therefore, the most part of the new liquidity injected into the financial system was left with bank reserve accounts at the Fed earning interest on a daily basis.
What the economy really required was subsidies and concessions to households and businesses until the economy was reopened and supply chains resumed. Therefore, the government implemented five legislative schemes of nearly US$ 7.3 trillions through fiscal deficit to provide funds to households and businesses during the period 2020 to 2022.
Therefore, the Fed’s new liquidity injection policy of nearly US$ 8.9 trillions was accommodative for the government to borrow funds at around zero interest rates to finance those special fiscal spending schemes. However, there were no signs of systemic liquidity problems or financial stability issues at the beginning of the Covid pandemic. Therefore, it is evident that the Fed or other central banks have no instruments to deal with non-financial crises that affect economies.
However, bank supervision has never been effective as shown by banking crises in the past including the contagious failures of several banks in April 2023. The Fed’s policy approach of separation between the monetary policy and bank supervision is proved inappropriate as banking risks and interest rates are two sides of the same coin.
Banks are exposed to risks of asset bubbles and interest rates consequent to monetary policy decisions taken without regard to the banking risks and soundness. Bank failures reported in March 2023 were related to interest rate risks that emerged from the rapid interest rate hiking cycle of the Fed’s monetary policy. Therefore, even the banks whose business model was to invest the most part of funds in long-term government securities went bankrupt due to market pricing losses consequent to consecutive interest rate hikes by the Fed.
However, the only benefit of the Fed or central banks supervising banks is the availability of the lender of last resort facility to bailout banks in the event of liquidity crunches. The latest instance is the story of the Fed providing nearly US$ 300 bn of fresh liquidity in few weeks to defuse the tremor of bank failures followed by the Silicon Valley Bank in March/April 2023.
Therefore, there is not real world evidence to prove that central banks are efficient in the conduct of both monetary policy and bank supervision under one roof due to the fault of the separation of the two policy models. It should be understood that the money and banking are inter-dependent or integrated activities that drive modern monetary economies. Therefore, economies across the world confront frequent fluctuations due to the manner in which central banks conduct the monetary policy.
6. Impact of Fed’s operations on tax payers’ money
In response to the related query, the Fed Chairman first stated that the Fed was self-funded. However, he accepted that, as the Fed’s profit is remitted to the government, the Fed’s financial outcomes affect tax payers.
This is where the DOGE will put its nose to the Fed operations and payments. Therefore, the DOGE will examine the staff cost as well as interest cost and liquidity facilities to assess the purpose of the Fed to tax payers. Public concerns have already been raised on excessive staff of the Fed. Further, payment on interest on adle reserves balances of banks as part of the short-term interest rate control is another concern, given its magnitude that has caused losses to the Fed and tax payers.
For example, such interest payment in 2023 stood at US$ 178 bn causing the Fed reporting an overall loss or net income of US$ 114 bn. The loss as at end of September 2024 is around US$ 63 bn. The President Trump has already suspended the Consumer Financial Consumer Protection Bureau funded by the Fed in view of its inefficiency and burden to tax payers. In addition, the purpose of US$ currency/liquidity swaps provided to help central banks of developed countries to stabilize their currency values at low interest rates will be questioned (similar to the USAID) as to what would be its benefit to American economy and public.
7. Fed’s position on government policies
Present Fed Chairman Gerome Powel’s position from the beginning has been not to make any comment on government policies. Accordingly, his standard reply has been that the Fed would assess the impact of government policies on the Fed’s mandate (price stability and maximum employment) and take appropriate policies to comply with the Fed’s mandate independently.
Accordingly, in response to a query on the possible impact on the Fed of radical policies announced by the President Trump through a large number of executive orders, the Fed Chairman stated that the government has the mandate to implement policies on tariff, immigration, fiscal policy, regulation, etc. as proposed and the Fed would look at the overall impact of such policies on the economy and take appropriate policies.
However, the Fed Chairman commented that the government debt levels at present are not unsustainable, but its path is unsustainable. However, the response of the Trump Administration is that such concerns over debt unsustainability are not due to the fault of the fiscal policy but due to unexpected high interest rate policies of the Fed. In addition, the Administration acknowledges the ineffectiveness of the Fed’s interest rate policies to keep inflation stable at 2% target. As the Fed Chairman confirmed the use of Treasury market structure as the conduit for the monetary policy, the scale of interest cost accumulating on government debt is largely driven by the Fed’s interest rates policy as debt is rolled over.
8. Fed’s role on sectoral distribution of the economy
Several queries were raised on how the Fed’s monetary policy contributes to various sectors and markets. However, the Fed Chairman clarified that, although the Fed looks at sectoral data, it finally considers aggregate economic data to make the policy decisions. Therefore, the Fed serves no role in promoting sectoral distribution of economic activities and credit as its policy decisions are aggregate data dependent based on lagged data series.
Impact of Trump’s intervention in the Fed
on central banks in the world
In view of the President Trump’s extreme nationalistic approach to make America great again by making the federal government efficient and cutting the corruption and regulations, the DOGE’s intervention in the Fed can be expected very soon.
- In the event the Fed’s operation model is questioned and legal amendments are made to restructure the Fed’s objectives and functions, it will cause tremendous tremor across all central banks in the world because the Fed’s operational models and policy language are invariably followed by other central banks.
- For example, central banks follow inter-bank overnight interest rate targeted policy rates and liquidity operations for the price stability based on a target inflation. This is known as market-based monetary policy model copied from the Fed. The IMF, World Bank and global investor community also canvas this model as a condition to attract their financial and technical support.
- Therefore, these central banks have openly given up catering to sectoral based economic growth, employment and living standards while securing the Fed’s version of independence from the government. Accordingly, central banks are seen operating as monetary kingdoms outside the public domain and agitating with the governments elected by the public to persuade fiscal policies accommodative to the monetary policy. The opposition political leaders and the network of economists have created a public perception that central bank are sorts of divine creatures whose true contribution is hampered by respective political governments for short-term agendas.
- On the topic being debated in the US whether the President Trump can remove the Fed President so that whole federal government falls under the newly elected President, some analysts state that the Fed is not the fourth branch of the government in the Constitution and, therefore, the President has the proper legal authority to appoint a new Fed Chairman at his discretion subject to the Senate confirmation.
- Accordingly, the Fed reform agenda expected will drive central banks to search for new policy models if they are to remain relevant to respective economies and societies. In that event, central banks will have to pursue sectoral growth and distribution models accommodative to fiscal policies while giving up unestablished academic hypotheses of price stability, inflation targeting and financial stability. This is what the modern monetary theory and supply side economics advocate.
- It was the sectoral growth model that central banks had pursued until 1980s before inventing the overnight inter-bank market liquidity based inflation control policy models which have miserably failed and destabilized economies.
(This article is released in the interest of participating in the professional dialogue to find out solutions to present economic crisis confronted by the general public consequent to the global Corona pandemic, subsequent economic disruptions and shocks both local and global and policy failures. All are personal views of the author based on his research in the subject of Economics which have no intension to personally or maliciously discredit characters of any individuals.)
P Samarasiri
Former Deputy Governor, Central Bank of Sri Lanka
(Former Director of Bank Supervision, Assistant Governor, Secretary to the Monetary Board and Compliance Officer of the Central Bank, Former Chairman of the Sri Lanka Accounting and Auditing Standards Board and Credit Information Bureau, Former Chairman and Vice Chairman of the Institute of Bankers of Sri Lanka, Former Member of the Securities and Exchange Commission and Insurance Regulatory Commission and the Author of 13 Economics and Banking Books and a large number of articles published.)
Source: Economy Forward
