Independence Jay? Inflation and attacks on the Fed

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1:32Economist Podcasts Team:The Economist

1:40Economist Podcasts Team:Hello and welcome to The Intelligence from The Economist. I'm your host, Jason Palmer. Every weekday, we provide a fresh perspective on the events shaping your world.

1:55Economist Podcasts Team:It's been six years since the real, final, official divorce between Britain and the EU. Time to take stock, then, of the economic effects of the breakup, and consider the benefits of, again, becoming maybe a bit more than just friends. And we take a look at self-help books down the ages. They are an ever-evolving indicator, not of what people want to become, but of what they are.

2:31Economist Podcasts Team:First up, though.

2:38Economist Podcasts Team:There aren't too many people who excitedly await inflation data from America's number crunchers. And the ones that came out yesterday were pretty short on drama. 2.7 % year-on-year was the headline number. Bang on what was predicted and the same as the month before. One keen watcher will have been President Donald Trump, who routinely uses the numbers as just another cudgel to beat Jerome Powell, chair of the Federal Reserve. Mr. Trump wants interest rate cuts, like, all the time. Mr. Powell wants to do his job, mainly keeping inflation down without crimping the economy, which has not meant cuts all the time.

3:16Economist Podcasts Team:And in what I guess could just maybe be a coincidence, Mr. Powell recently became the subject of a Department of Justice investigation. This is grave stuff, and the normally reticent Mr. Powell took the extraordinary step of saying so on camera. This new threat is not about my testimony last June or about the renovation of the Federal Reserve buildings. The threat of criminal charges is a consequence of the Federal Reserve setting interest rates based on our best assessment of what will serve the public, rather than following the preferences of the president. So what is the Fed doing and how much can it hope to keep a free hand in what it does?

3:57The broader story on inflation is that it's most of the way back down to the Federal Reserve's 2 % target.

4:04Economist Podcasts Team:Archie Hall is our U.S. economics editor. But that very last bit, squeezing it all the way back to 2, has proven a good bit more difficult than it may have initially seen. So we're now looking at annual inflation numbers of around 2.7 on the headline numbers, 2.6 on the core numbers. that very last bit, that sort of 2 % to 3 % range, is pretty much where inflation has lingered for a while. And some of that story of tariffs related, certainly the pass-through of the tariffs to goods inflation in particular has kept that number up. But also in general, across the inflation basket, it does seem like that very, very last squeeze is proving particularly hard to make happen.

4:37Economist Podcasts Team:So quite apart from what Mr. Trump might insist upon, what do you suppose the Federal Reserve should be doing in light of the difficulty in squeezing the last bit out? It's a bit of a balancing act, as the Federal Reserve has acknowledged. On the one hand, you do have inflation that is a little bit too high for comfort. That on its own would point towards wanting to keep monetary policy a bit restrictive, so keeping interest rates a little bit higher, trying to squeeze a little bit of the air out of the economy. On the other hand, what makes this a bit of a difficult time, even aside from the political pressures, is that the labour market, the other side of the Federal Reserve's so-called dual mandate, is looking a little bit wobbly.

5:10People have, I think, overstated the weakness somewhat. There was a lot of noise in the numbers because some of the immigration cracked down over the course of the past year, which really, really pulled down the growth rate of the population, distorted things. But it does seem like, even if you look through that, the unemployment rate has crept up a little bit. We're seeing still even accounting for immigration, a slightly slower rate of job creation than be entirely comfortable. Chair Powell of the Fed has called this curious balance, where both legs of the Fed's mandate are slightly pulling in different directions.

5:40The projections of most Fed members are for a tiny bit more cutting, but really not very much. But obviously, that's very different from the president's preferences.

5:49Economist Podcasts Team:Well, and whatever the job is, it's made harder, in fact, by this now criminal probe into Mr. Powell. What's been pretty striking is that throughout pretty much the past year, where there's been attack after attack by the president on the Fed, both rhetorically and also attempts to fire a Fed governor and much else besides, the strategy the Fed seems to have taken is to basically be silent and effectively hope his attention moves elsewhere. And what's really notable about this moment now is that finally this Department of Justice investigation, this dispute over the renovation costs of the Fed and the subpoenas that were issued late last week have prompted the Fed to actually stand up and really for the first time sharply rebuke the president.

6:28So we got a video statement from Jerome Powell saying in no uncertain terms that this was not a matter of building renovation, that this was about interest rates and this was specifically about the president's desire to push interest rates lower than would make sense, effectively countervailing the independence of the Fed. And so that was a very stark moment. And then what's strange and bizarre about this is that after that escalation by the Fed, we've effectively had radio silence from the president. He was called up by NBC News shortly after the Fed statement, and he effectively disavowed all knowledge of the DOJ probe and said if he wanted to put pressure on the Fed, this is not how he would do it.

7:00And so we're now in this slightly strange limbo.

7:02Economist Podcasts Team:And that much more pointed threat to the Fed's independence will have made markets around the world some kind of nervous. How have markets reacted? It's sort of strange. There's not really been a sharp market reaction. So immediately as the news broke, there was a little bit of a move down in stocks. There was a very sharp move up in precious metals, which is a feature of what people often call the debasement trade. So the notion that if we are going to have no Federal Reserve independence, giant deficits, and effectively the government's going to start inflating its way out of its problems, then you don't want to hold US dollars.

7:35You'd much rather hold something real and solid like gold or silver or whatever it is. So there was a bit of that by the market, but bond yields didn't spike up. And this is a bit cloudy because the president did walk back, as I mentioned, pretty soon after the news came out. So it's not like Liberation Day where President floated a giant tariff regime, there was a vast market backlash, and then there was at least a partial walk back the next week. But so far, certainly it does seem that for whatever reason, partly because that presidential walk back, partly because of what people often call the taco trade, that Trump always chickens out.

8:06But some combination of those factors seems to be preventing markets from really appreciably throwing a hissy fit in the way you might have expected would have happened in any other kind of normal situation where you have such direct and overt interference potential banking independence by a president.

8:20Economist Podcasts Team:Is this, do you think, at least in part, not an attack directly on Mr. Powell, but a signal to whoever's going to take his place, he won't be around forever after all? That's pretty incredible. I mean, certainly, look, if you're Donald Trump, Jerome Powell's out in a matter of months. And so the notion that you pick a giant fight that riles financial markets and annoys a number of lawmakers on your own side merely in order to pressure someone who's not going to be running the Federal Reserve by the middle of the year seems pretty peculiar. And certainly some of this may well be either the president being impulsive or impulsive behaviors given he's disavowed some knowledge of this by people kind of below him in the administration.

8:54But another way to read this and something that definitely accords with the broader thrust of how this administration's approach to the Federal Reserve is as a yet another ratcheting up of the pressure on the institution across the board and reasserting the notion that the White House will step in and will really, really push people if they think that that is misbehaving. The attempt to fire the Federal Reserve Governor Lisa Cook is another example of that. And as you've looked forward, we don't yet know who is likely to succeed Chair Powell, but it's going to be someone chosen by the President.

9:24So therefore, almost certainly someone who is going to be a lot closer to the President than Powell was. And of course, it's not just about the chair, it's also about all the other people on the Open Markets Committee who actually collectively vote on and decide interest rates, all of whom in general have a lot more job security than almost anyone else in the government in terms of their insulation from interference by the president. But of course, all of these moves will be hanging over all of these people. And as that pressure lines up, we could well, and certainly this is not guaranteed, it's probably not even likely, and the markets certainly aren't pricing it in, but it's certainly plausible that we end up in a world where as this pressure ratchets up, we really get quite overt action by the White House to get not just the chair, but even other members of the board to be compliant.

10:05We've not seen that yet, but that's sort of the direction of travel if this amping off of pressure continues.

10:10Economist Podcasts Team:But if that's the direction of travel, then the end of the road is a completely dominated central bank and you end up in a situation like, I don't know, in the extreme case, someplace like Turkey? Yeah, it's definitely a pretty troubling hypothetical. Those sorts of cases, I mean, Turkey being one, Argentina being another, cases where you really do have total control by the central government and debt-ridden fiscal authority of central banking lead you to some pretty scary places. So certainly if Donald Trump decided to in some way assert total control over the Fed, Yank interest rates all the way down, induce inflationary boom that devalues the US dollar, there's some pretty scary hypotheticals you can get to.

10:45And of course, the difference between the US and somewhere like Turkey is just how globally important the US is, how globally important the dollar is, and all the ramifications of that. Even as that's a useful hypothetical to caution against any comfort and calm about the idea that central bank independence could be seriously eroded, it's also worth appreciating how long the road is away from that. Even at this moment, Trump has seemingly stepped back slightly. There are still an awful lot of roadblocks, both literal, legal, institutional, and also in terms of market response, the ability of congressional and Senate Republicans who are not terribly happy about this.

11:20How old news, by the looks of it, to push back. They stand in the way between the US and that scenario. If that's even what the president wants, which is, despite all his shouts and complaints on True Social, not entirely clear either.

11:32Economist Podcasts Team:Archie, thanks very much for your time. Thank you. On our subscriber-only sister show, Money Talks, my colleagues are going big on these attacks on the Fed and how they're kicking dangerously at the foundations of the global monetary order. Find Money Talks tomorrow and every Thursday, wherever fine podcasts are sold and traded.

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13:33Economist Podcasts Team:The Economist in 2016, I guess. The British people have spoken and the answer is, we're out. As divorces go, this one turned out messy because the marriage was complicated. Brexit means Brexit. This is the second deal and the fourth vote three and a half years after the nation voted for Brexit. But then, finally, it was done in January 2020. This is an amazing moment. for this country. We have our freedom in our hands, and it is up to us to make the most of it. So, let's have a little lookie six years on from that amazing moment. The numbers are a bit complicated because of that whole global pandemic thing, but the shape of the curve is clear, and I promise that what follows will not include the phrase, we told you so.

14:32I think almost all studies that have appeared in recent years match the studies that were made even before the referendum, which is to say if you decide to leave your closest market and your closest allies and to erect new barriers to trade, your economy is going to suffer.

14:51Economist Podcasts Team:John Peete is an associate editor at The Economist and was for all of those years and I guess still is our Brexit editor. and I think all of the evidence is that the British economy has suffered as a result of Brexit. The argument is about how big is that effect and most of the recent studies suggest that the effect may be slightly bigger than people even expected in 2016. The cost of the British economy could be as high as 6-8 % according to some estimates but a general consensus is anyway it could be at least around 4%. Not the end of the world but not very helpful to an already very slow growing economy.

15:29Economist Podcasts Team:Well, the not the end of the world part, I suppose, is worth examining. In what ways has it not turned out to be as bad as the doomiest doomsayers suggested? I think some people claimed that Brexit would be a disaster for the city of London. Brexit would do serious damage to British services exports, that somehow or other the UK would fall behind the rest of Europe. And actually, the city of London is still the biggest financial centre in Europe. Services exports have generally held up well. And actually, Britain is still somewhere in the middle in terms of its position in the European Growth League.

16:06But that is worse than it was before 2016. So the damage is there, but it hasn't destroyed a reasonable economy.

16:13Economist Podcasts Team:So in talking about the damage that has been done, what can we now put a finger on? I think you can say that business investment has fallen significantly in the last few years by about 10 % compared with before the vote. manufacturing exports, particularly generally exports of goods, down perhaps 15 % compared with pre-pandemic levels. And services exports have risen, but most estimates say they would have risen even more had Britain not left the European Union. The Labour government, the one currently in power, has been saying that it wants to patch things up in various ways with the EU in a bid to kind of get back some of the benefits of the EU.

16:54Economist Podcasts Team:Talk me through that. What closer ties are realistic to expect at this stage? The issue of how much closer the relationship with the EU could become is a very, very difficult one. I mean, the Labour government that was elected in May 2024 was pretty cautious to begin with. The manifesto it was elected on said no to the customs union, no to the single market, and no to free movement of people. Those red lines constrain quite heavily what you can do to improve relations with the European Union. but particularly in the last two or three months the Labour government is starting to say look we really need to improve our relationship we're willing to align with single market rules we'd like to improve farm trade we are open to a freer exchange of young people but most of those suggestions it's sort of called a reset of the relationship with the European Union add up to quite small beer I mean we're talking about a boost to the economy of no more than about 0.3%, which is not very much when you think that Brexit may have cost the economy a 4%.

17:57Economist Podcasts Team:And the question that's not addressed there is how much the EU wants to extend a hand. What's in it for them? Are they interested in these closer ties? I think the issue of whether the European Union really has a lot of interest in improving relations with the UK is a tricky one. I mean, some people, particularly in Brussels and Paris, have been saying, look, when the Labour government came in in 2024, we might have been interested in talking to them about improving the relationship, possibly even reversing the decision that you took to leave the European Union in the first place. But nowadays, they tend to say, look, we've got lots of other problems.

18:31We have other priorities. We have to deal with Russia. We have to deal with Donald Trump. The UK is not a high priority. The current relationship works quite well for the EU, even if it doesn't work so well for the UK. They will tend to say, look, if you really want a much closer relationship, you're going to have to accept much more obligations. You're going to have to pay money into the European budget. You may have to accept much freer movement of people. And until you're willing to sign up to those obligations, we're not very interested in a lot of negotiation over details that we don't think will benefit us as much as it might benefit you.

19:06Economist Podcasts Team:And what about the British body politic? The polling has shown pretty clearly over the years, a greater and greater share thinking that Brexit was a mistake. When confronted with these same questions again, the obligations to chip into the EU budget and freedom of movement and what have view there is still going to be tension within British society about a lot of these questions. Yes, the evolution of public opinion in Britain is a fascinating subject. I mean, it is clear from all polls, including a poll that we conducted just before Christmas, that quite a substantial majority of people think Brexit was a mistake, and they don't think Brexit has been good for them.