Trump’s crusade against the Federal Reserve will be self-defeating

There are two ways, the world’s central bankers learned at this year’s Jackson Hole conference in Wyoming, to tame a horse. You can break the animal with fear, but it will never forget the pain. The kinder way, demonstrated to attendees one evening, is to establish consistent boundaries, enforced with gentle consequences like noisy clapping. This, says Martins Kazaks, president of the Bank of Latvia, is much like central banking. Although you can raise interest rates to crush inflation, at the cost of a recession, it is better when everyone believes in the inflation target, such that nobody raises prices and wages in the first place. If the boundaries are credible, the central bank can be gentler.

The unofficial theme of this year’s event was the imperilled credibility of the Federal Reserve. President Donald Trump has for months sought interest-rate cuts in spite of tariff-driven inflation, only to be met with stoic resistance from Jerome Powell, the Fed’s chair, who will leave his role in May. In the run-up to the conference Mr Trump called on Lisa Cook, one of the Fed’s governors, to resign for alleged improprieties in her mortgage applications; he may try to sack her. Mr Powell’s last speech at Jackson Hole as chair was preceded by its own clapping: a standing ovation that felt like an act of solidarity. Yet Mr Trump may soon get what he wants, for Mr Powell struck a doveish tone.

Some attendees thought that the president’s pressure was telling at last. But there was also earnest debate over the best response to tariff-driven price rises. Take one cornerstone of macroeconomic theory: the “Taylor principle”. It requires central banks to raise interest rates by more than any increase in inflation above the 2% target. Tariffs will have added 0.8 percentage points to core inflation by December, according to Goldman Sachs, a bank. Applying a simple version of the Taylor principle, rates would need to be more than 0.8 percentage points higher than they would have been without the tariffs, for any given state of the labour market.

Although the Taylor principle is part of a rule that near-perfectly described central banks’ behaviour from 1987 to 1992, at Jackson Hole, Emi Nakamura of the University of California, Berkeley, showed that over a much longer period the Fed has frequently deviated from it. Rich-world central banks often ignore disturbances, trusting that inflation will return to target when the shock subsides. The more credible the central bank, the better this works: expectations of low inflation can be self-fulfilling.

This kind of thinking got Mr Powell and his colleagues in trouble after the covid-19 pandemic, when they wrongly argued inflation would be transitory. Yet the Fed did eventually slay very high inflation, despite not having tightened monetary policy by as much as the Taylor principle demanded. In contrast, countries where interest rates rose fast and high—a group The Economist dubbed “hikelandia”—suffered even worse inflation than America. The Fed’s credibility seems to have helped at least.

How much does it have left? Many, including Ms Nakamura, suggested that post-pandemic inflation may have done some damage. At the same time, Amir Yaron, governor of the Bank of Israel, mused that inflation’s eventual fall could have reinforced the idea it will always return to target. The bookmakers’ favourite to replace Mr Powell is Chris Waller, a Fed governor who at the last monetary-policy meeting dissented in favour of a rate cut. Mr Waller’s arguments hinge on evidence that long-term inflation expectations remain in check.

Mr Trump’s threats loomed awkwardly over the debate. And therein lies the irony of the president’s campaign against the Fed. If the public suspects political influence at the central bank, it becomes harder, not easier, to have both low rates and low inflation. And it is ominous that long-term bond yields have not fallen much since the Fed started cutting in 2024; investors, it seems, see a risk that inflation or interest rates will stay high.

That may be because the political danger will outlast Mr Trump. One reason the president wants looser money is to make it cheaper to service America’s net national debt, which stands at nearly 100% of GDP. Even accounting for revenue from the president’s tariffs, America is likely to run a deficit of about 6% of GDP this year. The more indebted the government becomes, the more politicians of any stripe are likely to interfere with the Fed.

Wild horses, we’ll ride them some day

Maybe demand for American government bonds can offer relief. Ludwig Straub of Harvard University showed how the flipside of ageing populations, which are exacerbating the rich world’s budget woes, is downward pressure on rates. Older folk require vastly more spending on pensions and health care. Helpfully, they are also wealthy, and their appetite for assets makes it easier for the government to sell Treasuries. Mr Straub and his co-authors calculate that America might be able to sustainably run up debts worth 250% of GDP by the end of the century without facing a crisis.

This was probably the conference’s most controversial calculation. Several attendees said the problem with high indebtedness is not a threshold, but that it leaves governments in a precarious position where slight changes to interest rates or a recession can cause far-reaching pain. “It is shocks not stocks that cause crises,” said Deborah Lucas of the Massachusetts Institute of Technology. Mr Straub then clarified on stage that the 250% number applied only in 2100, not today, and also that today’s deficits are not sustainable. “We need a massive fiscal adjustment no matter what.”

That looks fanciful with Mr Trump in office—or, frankly, anyone else. Hence the fear that independent technocracy is in peril. Fighting inflation was delegated to central bankers because, like taming horses, it requires patience and discipline. But governments can always re-open the pen, and allow the animal to bolt.