The Ghost of the 1970s Inflation Returns: When the Fed Faces the Risk of Losing Independence

The Repeating History of the Fed’s Independence in the Face of the Greatest Challenge Since the 1970s Inflation Crisis A public confrontation between the White House and the US Federal Reserve (Fed) is raising deep concerns among global economic and financial circles about the risk of political interference in monetary policy. This is not a new debate but a issue that has historically had serious consequences in US economic history, especially during the prolonged high inflation period of the 1970s. Direct Challenge to Central Bank Independence Fed Chair Jerome Powell recently stated that the threat of criminal liability from the US Department of Justice against him should be viewed in a broader context: that is, pressure to force the Fed to cut interest rates. According to Powell, the official reason related to the Fed headquarters renovation project is just an excuse, while the real goal is to influence monetary policy decisions. He emphasized that the current dispute is not merely about oversight of spending or Congressional authority but a fundamental question: whether the Fed is still allowed to set interest rates based on economic data and scientific evidence, rather than succumbing to political pressure. Powell warned that any form of threat or intervention could undermine the Fed’s dual mandate of price stability and maximum employment. Why the Market Reacts Strongly The Fed is designed to operate independently from the executive branch, with fixed terms for governors to avoid influence from election cycles. This independence has long been the foundation reinforcing market confidence in the US dollar and US Treasury bonds. Immediately after Powell’s remarks, the US dollar weakened and gold prices rose, indicating that investors are very sensitive to any signs that monetary policy could be manipulated by political motives. This reflects concerns that if the Fed loses its independence, confidence in its ability to control long-term inflation in the US could also be shaken. Costly Lessons from the 1970s Current concerns evoke memories of the Nixon era when the White House exerted strong pressure on then-Fed Chairman Arthur Burns to maintain loose monetary policy to promote growth and employment ahead of the 1972 election. Declassified tapes and documents later revealed Nixon repeatedly pressured Burns to prioritize short-term political goals. Although inflation in the 1970s was influenced by factors such as oil shocks and fiscal expansion, Fed research and economic historians point out that political pressure caused the Fed to respond slowly to inflation risks. As a result, by 1974, inflation in the US exceeded 12%, eroding consumers’ purchasing power and causing serious instability in financial markets. The price of this loss of credibility was enormous. In the late 1970s and early 1980s, Fed Chairman Paul Volcker had to raise interest rates close to 20%, accepting a deep recession to restore confidence in US monetary policy. This became a classic lesson in economic history about the vital importance of central bank independence. Why the Current Moment Is Especially Sensitive Economists believe that today’s debate is more significant than ever because it occurs against the backdrop of high US public debt, persistent inflation above pre-pandemic levels, and increasing reliance on bond issuance to finance budget deficits. In such an environment, confidence in the monetary management mechanism plays a crucial role in anchoring inflation expectations and maintaining foreign investor demand for US debt. If markets believe that interest rate decisions are influenced by political pressure, long-term borrowing costs could rise even if short-term rates fall. This is the so-called “credibility premium,” reflecting a loss of trust rather than purely economic factors. Conclusion Although the White House seeks to downplay concerns and claims this is merely an oversight issue, Fed Chair Jerome Powell dismissed this explanation, affirming that he will continue to pursue his mission “fearlessly and without bias.” History shows that when the independence of the Fed is eroded, the costs to the US economy and the global economy can be very high. Therefore, today’s confrontation is not just a temporary political issue but a crucial test of the credibility and long-term stability of the US monetary system.