Who Controls Your Interest Rate?

It's Thursday, April thirtieth, and welcome to HigherIQ. Yesterday, Jerome Powell held what will almost certainly be his last press conference as Chair of the Federal Reserve. His term ends May fifteenth. Kevin Warsh, President Trump's nominee to replace him, advanced from the Senate Banking Committee hours earlier on a party-line vote. But the biggest news wasn't the succession. It was what Powell did next. He announced he would stay on the Federal Reserve Board of Governors "for a period of time to be determined," citing the Trump administration's legal attacks on the institution. He called those attacks "unprecedented in our one hundred and thirteen year history." It's the first time a Fed chair has remained on the board as a governor since 1948. To understand why that matters, you need to understand what the Federal Reserve actually does, why it was designed to be independent from the president, and why that independence is now being tested in ways it hasn't been since the institution was created. The Federal Reserve was created by Congress in 1913, after a series of bank panics, most severely the Panic of 1907, convinced lawmakers that the country needed a central institution to stabilize the financial system. Its original job was narrow: be the lender of last resort, the institution that banks could borrow from when nobody else would lend to them, to prevent panics from cascading into full economic collapses. Over time, the Fed's responsibilities expanded. In the 1970s, Congress gave it what's known as the dual mandate: promote maximum employment and maintain stable prices. In practice, this means the Fed tries to keep unemployment low and inflation at around two percent per year. It does this primarily through one tool: interest rates. When the Fed raises the federal funds rate, the interest rate banks charge each other for overnight loans, borrowing becomes more expensive throughout the economy. Mortgages cost more. Car loans cost more. Business loans cost more. People and companies spend less. The economy slows, and inflation comes down. When the Fed cuts rates, the reverse happens: borrowing gets cheaper, spending increases, the economy heats up, and jobs are created. This is an extraordinary amount of power for an institution that nobody votes for. The seven members of the Board of Governors are appointed by the president and confirmed by the Senate for staggered fourteen-year terms, specifically designed to insulate them from political pressure. No single president can appoint a majority of the board during a single term. The Fed doesn't receive its funding from Congress. It generates revenue from the interest on government securities it holds and from fees charged to banks. It is, by design, the most independent institution in the federal government. It answers to Congress in theory but operates without congressional approval in practice. The rationale for this independence is straightforward and supported by decades of academic research. Elected politicians face elections. Elections reward short-term economic growth. A president who wants to be reelected has every incentive to push for lower interest rates, which stimulate the economy and create jobs in the near term, even if doing so produces inflation in the long term. If the president controlled interest rates directly, the economy would run hotter before every election and suffer inflationary hangovers afterward. Countries whose central banks lack independence have historically experienced higher and more volatile inflation. The Fed's independence is the mechanism that prevents the person who benefits from a booming economy from being the same person who controls the levers that create one. The tension between presidents and the Fed is not new. What is new is the intensity and the tools being used. Lyndon Johnson reportedly shoved Fed Chair William McChesney Martin against a wall in 1965 after the Fed raised rates over Johnson's objections. Richard Nixon pressured Fed Chair Arthur Burns to keep rates low before the 1972 election, and Burns largely complied, a decision many economists view as contributing to the severe inflation of the late 1970s. That inflation eventually required Paul Volcker, appointed by Jimmy Carter, to raise rates to nearly twenty percent in 1981, triggering a brutal recession that brought unemployment to almost eleven percent. Volcker is now widely regarded as one of the greatest Fed chairs in history, precisely because he was willing to cause enormous short-term pain to fix a problem that political pressure had created. The lesson the economic establishment took from the Burns-Volcker era was that central bank independence isn't abstract. It has direct, measurable consequences for the cost of groceries, the interest rate on your mortgage, and the value of your savings. When the Fed bends to political pressure, inflation follows. When it resists, the economy is more stable over time, even if individual decisions are unpopular. Trump's conflict with the Fed has been more sustained and more aggressive than any president's in modern history. During his first term, he called Powell "clueless" and said the Fed was "the only problem our economy has." During his second term, the pressure escalated. Trump publicly demanded rate cuts, threatened to fire Powell, and his Justice Department opened a criminal investigation into the renovation costs of the Fed's headquarters building. A federal court threw out a subpoena issued by U.S. Attorney Jeanine Pirro, calling the investigation legally flawed. The probe was dropped last Friday, but not before it achieved what many observers believe was its real purpose: signaling to the Fed that defying the president carries personal and institutional consequences. Powell's decision to stay on the board as a governor is his answer to that signal. By remaining, he denies Trump an additional seat to fill on the seven-member board, preventing the president from assembling a majority of his own appointees. Powell said he was not staying for political reasons. "I'm literally staying because of the actions that have been taken," he said. "I had long planned to be retiring." He called the legal attacks on the Fed "unprecedented" and said he worries they are "battering the institution and putting at risk the thing that really matters to the public." The transition to Kevin Warsh is not just a change of personnel. Warsh has promised what he calls "regime change" at the Fed, including new economic models, a new communications strategy, a smaller balance sheet, and a new inflation framework. He has historically advocated for lower interest rates, which aligns with Trump's public demands. The contrarian question is whether Fed independence, as it's currently practiced, actually serves the public as well as its defenders claim. Critics from both the left and right have argued that the Fed's independence is overstated and that its decisions disproportionately benefit financial markets and wealthy asset holders. When the Fed cut rates during the COVID pandemic and bought trillions in government bonds, asset prices soared, benefiting stockholders and homeowners while doing less for workers and renters. The Fed's response to the 2008 financial crisis similarly bailed out banks while millions of Americans lost their homes. The institution that's supposed to serve the public has, at times, appeared to serve the financial system first. This is a legitimate critique, and Powell himself has acknowledged that the Fed's tools are blunt instruments that don't distribute their effects evenly. But the alternative, a Fed that takes its orders from the White House, has been tried before and produced the inflation of the 1970s. The question isn't whether the Fed is perfect. It isn't. The question is whether the costs of political control would be worse than the costs of imperfect independence. The historical record suggests they would be. Yesterday's meeting ended with an unusual 8-4 vote to hold rates steady at 3.5 to 3.75 percent. Four dissents on a single decision is rare and reflects genuine disagreement about where the economy is headed. Inflation is above three percent, driven partly by the Iran war's impact on energy prices. The job market is softening. The Middle East ceasefire remains fragile. Warsh will inherit all of this, along with the most politically charged Federal Reserve in decades. So if this comes up in conversation, here's how to think about it. The Federal Reserve controls interest rates, which affect the cost of everything you borrow and the return on everything you save. It was designed to be independent from the president so that no politician could juice the economy before an election at the cost of inflation afterward. That independence has been tested by every president since LBJ, but never as aggressively as now. Trump's Justice Department investigated Powell, threatened to fire him, and publicly demanded rate cuts. Powell responded by announcing he'll stay on the board as a governor, the first former chair to do so since 1948, to prevent Trump from filling his seat. His successor, Kevin Warsh, has promised regime change and favors lower rates. The Fed isn't perfect and its tools don't distribute their benefits evenly. But the alternative, a central bank that does what the president tells it to do, has been tried before, and the result was the worst inflation in modern American history. The most important economic institution in the country is changing hands. What happens next affects the interest rate on your mortgage, the price of your groceries, and the value of every dollar in your bank account. Stay informed, stay curious, and we'll see you tomorrow.