Ex-New York Fed President Bill Dudley on Trump and Central Bank Independence

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1:02Bloomberg Audio Studios. Podcasts, radio, news. This is exactly why we like to see central bank independence, because central bank independence is thinking about monetary policy, not for the next 18 months, but for the next few years.

1:26I'm Stephanie Flanders, head of government and economics at Bloomberg, and this is a bonus episode of Trumponomics, the podcast that looks at the economic world of Donald Trump. While I was in New York this week, I hosted a fireside chat with Bill Dudley about the future of the Federal Reserve and its monetary policy. Bill was once president of the Federal Reserve Bank of New York. Before that, he was a chief economist at Goldman Sachs, among other things. He's now a columnist for Bloomberg Opinion and a senior advisor to Bloomberg Economics. In our conversation, we discuss not only the political threats to Fed independence growing by the day under President Trump's administration, but also the US central bank's monetary policy right now, and the implications of tariffs and the AI investment boom.

2:12I started the conversation by asking Bill why he thinks it would be a bad idea for the Fed to keep cutting interest rates over the next year or so, which is what the future markets are currently predicting.

2:27Well, I think there's a debate going on between what's the biggest risk? Inflation's staying sticky above the Fed's 2 % target for if we go through next year, the fifth year in a row, or the labor market continuing to deteriorate and potentially giving away and having a recession. And Powell's trying to navigate between those two risks. And as he said, it's very difficult to figure out what to do in the current environment. Where he lands is that he thinks that the greater risk, or the increasing risk at least, is the downside risk to the labor market. And as a consequence of that, he wants to make monetary policy less restrictive to sort of reduce that downside risk to the labor market.

3:10Now, I think you could make the argument that the upside risk to inflation still is very much germane because the pass-through of tariffs into prices is probably quite incomplete. And we have a number of other exogenous factors that are going to also put upward pressure on inflation. For example, what's happening with the AI investment boom and the consequences of that for electric prices. Now, I know we like to historically exclude food and energy from our calculation of inflation, and that's fine when the prices go up and the prices come right back down, but that's not going to happen for electricity.

3:45The prices are going to keep going up for the next few years, and so I think that has to be considered a part of the inflation outlook. I think where I come out is a little differently than Powell. I think that the inflation risks are just as substantive as the downside risk to the labor market, number one. And number two, I don't think policy is as restrictive as he thinks it is. He thinks that policy is restrictive, so therefore he wants to make it less restrictive. I think if you look at the economy writ large, it doesn't look like monetary policy is holding back the economy hardly at all at this point.

4:18If you look at the Atlanta Fed GDP Now forecast for the third quarter, it's tracking 3.8%. If you think about the exogenous AI investment spending boom, that's going to continue to support economic growth as we go through the rest of 2025 into 2026. So that's the first point of sort of mild disagreement. The second point is I just feel like the risk of inflation expectations rising is just as substantive as the labor market continue to deteriorate. what paul's worried about in the labor market is that when the labor market deteriorates beyond a certain point it tends to be self-reinforcing and this is really summarized in the somn rule every time the unemployment rate's gone up by half a percent the u.s has fallen to reception with one important exception 2024 2024 we had a mild trigger of the somn rule nothing bad happened but i think that notion that labor market deteriorating beyond a certain point is still valid because what happened in 2024 was the unemployment rate went up not because of labor market weakness, but because of a big surge in labor supply.

5:22This year, if the unemployment rate goes up by half a percentage point, it's going to be because of weakness in labor demand. What concerns me on the inflation side is, you know, we're sort of pushing the envelope here of how long inflation can be above the Fed's target and inflation expectations stay well anchored. At some point, people are going to start to believe that the Fed doesn't really care about getting inflation back to 2%, that 3 % is good enough. And if that happens, then inflation expectations will become a bit less firmly anchored, and then it'll be harder to get inflation down in the future.

5:52So my own personal view is I'd be a little bit more patient. Also, I think there's just a tremendous amount of uncertainty in terms of the economic outlook. We've never had a tariff shock like this. We've never had an AI investment spending boom like this before. We've never had such a dramatic change in labor supply before. So there's a whole bunch of you know, wild cards that I think would, in my mind, make me less confident in my forecast. And if I'm less confident in my forecast, I'm going to be sort of like, you don't want to take the democratic oath of do no harm. That's fantastically useful to run through all those.

6:27Let's just pick up, there's a couple of things from there about what constitutes restrictive, but also about the pass-through of the tariffs. You know, there is just a lot of uncertainty, and so far things have not necessarily played out, certainly the way we might have expected from the models. It's a puzzle, frankly, on all sides of the newsroom in Bloomberg as well because we're talking to people in senior business figures who appear to be kind of nervous of mentioning tariffs in their earnings calls. If it's not being shown in prices, these tariffs which are definitely being paid at the border, you'd expect it to be shown in earnings, but we're not seeing an obvious effect there.

7:04Our own Anna Wong has suggested that even just the sheer uncertainty attached to the tariffs this time around, the fact that they're jumping around so much, has actually stayed manufacturers' hand in changing prices because they think, oh, well, there may be a tweet next week and he may suspend it for another few months. So just on that, what's your sort of solution to the puzzle of how tariffs are or are not actually being shown in the economy and prices particularly? Well, first of all, I think the pass-through process just takes a little bit longer than we expect because the goods have to move from abroad to the U.S.

7:39They have to be unloaded, shipped to the retailer, and the retailer actually has to sell the goods at the higher price, and that takes a number of months. Number two, to your point, the uncertainty level is really high. And I think when uncertainty is really high and there's a cost of raising prices in terms of your customer relations, you want to get more certainty before you decide how big of a price rise that you want to put into place. So it's better to raise the prices once rather than raise the prices multiple times. So I fully expect that most of the tariff burden is ultimately going to be passed through, probably on the order of 80%.

8:15And I think that's probably going to be worth 1 % to 1.5 % on the level of prices. So I'm pretty confident that inflation is going to be 3 % or more well through the first half of 2026. So I think it's more delayed than not coming. Because to your point, if it's not showing up in earnings, then we're going to be seeing it at some point. And on the question of whether it's restricted, obviously one of the arguments that's been used by Stephen Myron and others for why it is actually more restrictive than we think the policy currently is that the natural rate has fallen for reasons that he described in his testimony.

8:56I think that the House view is certainly that that's not the case. But is that one of the things that you're thinking about in looking at considering whether policy is restrictive enough? Well, as Chair Paolo says, we know our star by its works. And what he means by that is we look outside, see how the economy is performing. If the economy is stronger than we thought, then we tend to revise up our estimate of our star. And if the economy is weaker than we thought, we tend to revise down our estimate of our star. I'd say right now, given all the uncertainty in policy, the tariff shock, you know, it is a tightening of fiscal policy.

9:30Given all that, you'd have to say the economy is performing better than expected. In fact, you know, at the last Fed meeting, the Fed revised up their growth forecast for 2026 by a couple tenths of a percent. So that, to me, tells me that our star is probably a little bit higher than we think. Now, you know, Stephen Moran made a number of arguments about why our star is lower. And I think some of the arguments are actually sensible, but some of them are not. And, of course, he conveniently, I think, ignored some of the factors that are also resulting in a higher R-star. The investment spending boom, for example, was just totally not even mentioned by Moran in his remarks.

10:04And it's hard to believe that the investment spending boom in the short term doesn't increase the demand for capital and result in a higher interest rate consistent with a neutral monetary policy. You know, the argument where I agree with him is on slower growth of the population, slower growth of the leader force. That one I think is, you know, a good argument because I think if you have less people, you need less capital to equip them to work. So I think that one was something I agree with. But the one, some of the other arguments I think are, he still are cherry picking the arguments to support his point of view.

10:34But the biggest problem is how does he explain, if the policy is as restrictive as he says it is, then why is the economy performing so well? There is this kind of mystic Meg aspect to the R-star debate. You have this feeling of you never can see it, never can put it down, but we talk about it a lot. We're going to talk about it more later. Finally, just on the short-term situation, given that you have been, unlike most of the people in the room, around the table for these discussions, how will the FMC be thinking about the shutdown and how important is it, the timing, if the government goes back to work, say, this week, although it's seeming pretty unlikely, What kind of difference does that make relative to it being what seems likely to be a pretty prolonged shutdown?

11:16So historically, these government shutdowns have not had a big effect on the economic trajectory. And the reason for that is people ultimately get paid even for the time that they were furloughed. So they don't actually adjust their spending habits in any significant way. But this shutdown could be a little bit different because there are people that apparently are going to be furloughed. There are people who are not getting paid. So it might have a more damaging consequence to the economy. Now, I think everybody's of the view that this is not going to last sort of indefinitely. You know, maybe it goes a month, maybe it goes five weeks, but I don't think anyone's expecting it to last for the end of the year.

11:53And so at the end of the day, the size of the shock that this is going to generate to the economy is pretty small. And I would think that it's unlikely that it's going to have a real big consequence for monetary policy. Now, the October meeting, I think the Fed is definitely going to ease. At this point, once you start to ease, you're almost going to certainly go in the same direction unless you get a new set of information that contradicts your motivation for easing in the first place. Since the Fed is getting virtually no information, of course, they're going to keep going in the same direction.

12:25Yeah, of course, that's a good point in terms of the BLS numbers and other things. OK, so, I mean, one thing that I like about your columns that you do for Bloomberg, Bill, and certainly why they get read, is that you have these admirably direct headlines that say basically what you're going to say. And if you'll forgive me, 4th of August column, the Fed is under siege and it'll be just fine. That was one column. Yeah, I changed my mind on that one. Three weeks later, just about the time that Lisa Cook was attempted to be fired, I wasn't very worried about the Fed. now I am. So if you are, why isn't Wall Street?

13:05That's a good question. I don't have a good answer for that. I guess Wall Street is just very uncertain how this all is going to play out. Obviously, the Lisa Cook case is going up to the Supreme Court, and how they rule is going to be really important. If they rule that President Trump can dismiss Lisa Cook for cause, then in principle, President Trump can dismiss other members of the Board of Governors for cause. And it's not even clear whether what his authority would be over the Federal Reserve Bank presidents. The fear in markets is that the Trump administration could soon get control of the Board of Governors.

13:41And then that majority on the Board of Governors could then start to decide not to reappoint Federal Reserve Bank presidents when their five-year terms come due in February of next year. And so you can see how you can bootstrap control of the Board of Governors to having control of the broad Federal Open Market Committee. Even if the Lisa Cook case is decided in favor of the president, I don't think this is preordained. We don't really know what Chris Waller and Michelle Bowman would do. I thought it was interesting at the last meeting that they went along with the majority for a 25 base point rate cut, not the 50 base point rate cut that Stephen Moran supported.

14:21So just because you're a Trump appointee doesn't mean that you're necessarily willing to do things as radical as not reappointing a Federal Reserve Bank president. These five-year reappointments historically have been absolutely routine. They've never been consequential in the past. So to not reappoint a Federal Reserve president because you're afraid that they're not a supporter of much lower interest rates would be without precedent. So I'm looking at a couple of things. Number one, the Lisa Cook case, hugely consequential. Number two, where are Michelle Bowman and Chris Waller in all of this, and how far are they willing to go in terms of transforming the Fed?

15:05Basically, dismissing Federal Reserve Presidents because you don't like how they're going to vote on monetary policy would be the end of Fed independence. And I think, to your point, it's remarkable that people are so optimistic about this, because even if it's a 20 percent probability, it's a 20 percent probability of a very bad event. As you talked at the top of this session, if Donald Trump were to get his way and get 1 % interest rates, we would have a much more significant inflation problem. Inflation expectations would become unanchored, and the yield curve would steepen. The bond market vigilantes would almost certainly return.

15:48The dollar would weaken sharply. We would have a pretty big mess on your hands. And even if that's only a 20 % probability, that seems like something that you want to price in. We did some scenarios thinking about how you might euphemistically call a different reaction function of the Fed under a new chair. I mean, one distinguishing feature of all of them, even the more extreme one, is that things look pretty good for a while and then they're really bad. and just looking at Donald Trump's policies sort of through time, he's been quite good at picking policies that were quite good for a while that he wouldn't necessarily pay the consequences of.

16:26Isn't that a reason to be a bit nervous? Well, this is exactly why we like to see central bank independence because central bank independence is thinking about monetary policy not for the next 18 months but for the next few years. You know, if you have an independent central bank, it can think medium to long term. If you have a central bank that's controlled by the executive branch and is worried about how things are going to look for the next election, yeah, you can basically make monetary policy very stimulative, make the economy look very strong. And the inflation consequence of that usually shows through later.

17:00There's been a lot of academic studies that have looked at economic performance based on how independent the central bank is. And the jury is in. The more independent the central bank, the better the economic outcomes. and this is the reason why we've been engaged in a movement to more central bank independence over the last 30 years. This is not a new trend. So if Trump moves this in the opposite direction, this is unwinding a lot of momentum that's been in place for several decades. We're going to run out of time, but I've got a couple of quick ones. One is, just as a matter of fact, given all the conversation around this, given the focus on the particular candidates, The Fed is traditionally, the FMC is a bit different, certainly from the Bank of England, that you tend to have unanimity.

17:43The chairman tends to command a lot of the room, so to speak. You don't have the governor or the head of the bank doesn't tend to be voted down in their decisions. That, as many people have said, that depends on the respect that the people around the table have for the chair. Do you think that anybody coming in in these circumstances now is tainted because of the process that's led up to it? No, I think it depends on how they perform in the job. So it's sort of up to them when they come in. Federal Reserve is a consensus-driven institution. I mean, the chair can lead, but it only leads so far.

18:15So the last meeting is a good example. There were some people who didn't want to cut rates at the last meeting. So you look at the outcome of the meeting, all the people except Moran voted for the 25 basis point rate cut. And so that's basically telling you is when the committee has confidence in the chairman, if the issues are small, the committee is oftentimes willing to defer to the chairman. But if the chairman wants to take the interest rates down 200 basis points and the committee thinks that's inappropriate, then it's not going to happen. So I think, you know, the chair can lead, but he can only lead so far.

18:50There's a question that came up in a meeting we had this morning. Do you personally think that Jay Powell will stick around, as he suggested? I think he's keeping his options open. I mean, I think if he thought that his presence was standing between good monetary policy and bad monetary policy, then I think he would stay on board. If he thought that his presence wouldn't make much difference, then I think he'll step down. So I think he's, right now, I don't think he knows the answer to that question. So I don't think he knows what he's going to do at this point. And the final question was just taking us full circle to the discussion we had around where the risks lie in the current decision.

19:26all this debate, you know, another potential consequences that I've actually heard investors talk about is that in a year or so's time, if you've had a sort of continued boost to the economy from some of these rate cuts, and it's actually inflation is starting to come back or come through, it could look like you really need to raise rates again. And the fear would be that a slightly more politically compromised Fed, whoever the chair is, will not want to do that in the lead up to a midterm election. Do you think that's another reason for holding now? Well, I think, you know, what you're getting to is, as we start this discussion about, you know, the independence of the Fed, even if the Fed retains its independence, there's always the question of whether the Fed is starting to pull its punches because it's worried about the consequences if it doesn't do the administration's bidding.

20:15I mean, already I've been asked a number of times, do you think the Fed cut rates in September because of the political pressure of the Trump administration? I don't think so. I think Paul believes that it's appropriate to worry about the downside risk to the labor market. But the very fact that people are asking me that question shows that there's already been some damage to the Fed's credibility. Yeah, that is just the kind of question that anyone on the Fed always hated. And certainly you always used to say that. Bill Dudley, thank you so much. Thank you.

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