Here's What Happens to the Economy if Trump Fires Jerome Powell and Installs a Loyalist at the Fed
The Fed should be replaced by free markets, not unbridled presidential power.
President Donald Trump wants to lower interest rates to approximately zero, a change that could goose the economy in the short term but in the long term would lead to roaring inflation. Federal Reserve Chairman Jerome Powell won't do that, and so Trump has been clearly communicating his dissatisfaction with Powell. And while Trump says he's "highly unlikely" to fire the man, that isn't a definite no—and Powell's term expires next May, so we're bound to see someone new in the job soon either way.
The names being kicked around for Powell's replacement include National Economic Council Director Kevin Hassett, financier and Stanford lecturer Kevin Warsh, Federal Reserve Governor Christopher Waller, and Independent Institute Senior Fellow Judy Shelton. Right now the smart money is on Hassett, a policy wonk who has held various positions in Washington, D.C., for 25 years. Hassett can be something of a Trump hack: He is constantly going on TV to defend the president's policies, however inane they might be. But he has also said all the right things about Fed independence, and he seems to be sincere about that.
Hassett believes that rates should be perhaps 1 percent to 1.5 percent lower. This would take monetary policy from a more restrictive stance to something approaching neutral. It is unlikely, given current economic conditions, that Hassett would be willing to lower rates below that, and at some point that would probably prompt another conflict with Trump.
Trump wants interest rates to be lower because he wants to rev the economy and generate more tax revenue without having to do the hard work of cutting government spending. He argues that high interest rates are hurting consumers; on the other hand, they are also helping savers. In the 2010s, when interest rates were zero, retirees were forced to buy high-yield bonds or stocks just to get a decent return. Lowering interest rates far below neutral levels causes excessive risk-taking and, eventually, speculative bubbles.
Many people mistakenly believe that when the Fed lowers interest rates, consumer rates—like those for mortgages or car loans—automatically go down as well. That is not necessarily true. Interest rates vary based on their term length, from short-term to long-term. Mortgage rates, for example, are tied to 10-year Treasury yields, not the short-term federal funds rate. In fact, when the Fed cuts the federal funds rate—an overnight rate—long-term rates can actually rise if investors expect higher inflation, and that could mean higher, not lower, mortgage rates. It is clear that Trump does not understand this. Long-term interest rates are set by the market, and unless the Federal Reserve gets into the business of manipulating long-term interest rates (which is possible), there's little a president can do to control rates on things like car loans and mortgages.
The Fed's Role
The chairmanship of the Federal Reserve is a powerful position, but monetary policy isn't set by one man acting alone. It's conducted by the Federal Open Market Committee (FOMC), made up of a subset of the seven governors and the 12 regional Fed presidents. This institution is driven by collaboration and consensus. The chair has the ability to guide that consensus, but the chair has only one vote.
The Fed conducts monetary policy by targeting the federal funds rate and doing open-market operations, like buying and selling treasury bills to massage the money supply. (It can also revise the reserve requirements for banks, though those rules haven't been changed in decades.) The Fed is also the biggest, most important regulator of the banking industry: It clears checks and payments, and it serves as a lender of last resort in the event of a crisis.
The biggest problem with the Fed is the idea that 19 bureaucrats know the correct interest rate to equilibrate supply and demand for loanable funds. A market made up of thousands of profit-motivated people will surely do a better job of setting interest rates than any group of bureaucrats in Washington, D.C. It's mind-boggling that the most important price in the economy—the price of money—is left to the government.
Those bureaucrats have made some big monetary policy mistakes in the past. In 2021–2022, the Fed declared that the inflation we were experiencing was "transitory" and neglected to do anything about it until it was too late. Another big error came in 2000–2003, when the Fed responded to the dot-com bust by lowering interest rates from 6.5 percent to 1 percent—and then left them there for more than two years, helping ignite the housing bubble and eventually the Great Recession.
Markets make mistakes as well. But those are usually quickly corrected, and the mistakes are punished with the loss of traders' money. Monetary policy mistakes tend to go unpunished. The last Federal Reserve chair to be relieved for incompetence was G. William Miller, back when Jimmy Carter was president—and he was rewarded with the Treasury secretary job.
Tensions at the Fed
It isn't clear that Trump has the ability to remove Powell even if he wants to. That hinges on a Supreme Court case, Humphrey Executor v. United States, that concerns the president's ability to fire the heads of independent agencies, which can typically only be fired for cause. Trump wants the ability to remove the heads of independent agencies for any reason. It's up to the Supreme Court to decide whether that's constitutional.
Treasury Secretary Scott Bessent has discouraged Trump from trying to fire Powell, saying that this would roil markets—and he's right. If Trump were to summarily fire the Fed chair, we would probably see the dollar weaken. Short-term rates would go lower, long-term rates (including mortgage rates) would go higher, and gold would skyrocket. As we've seen in other countries, such as Argentina and Turkey, politicizing the central bank can lead to inflation, currency debasement, and social upheaval.
The July 30 FOMC meeting displayed the current tensions at the Fed. It marked the first time that two governors dissented together in over 30 years: Christopher Waller and Michelle Bowman, both Trump appointees. Waller has been calling for easier monetary policy since December 2023. The thinking is that monetary policy is excessively restrictive, inflation has cooled, and inflationary pressures seem to have disappeared, so if you have the ability to lower rates, why not do it? Powell, for his part, cites the unknown effects of Trump's tariffs in keeping interest rates high. He is right to be vigilant about inflation, especially since he wasn't in 2021.
Of the current candidates for Powell's job, Kevin Warsh would probably be the best choice. He shares Hassett's view that rates should be lower in the short term, but he would probably be a better bulwark against Trump's bullying.
Regardless of who becomes chair, that person would have to move heaven and earth to lower rates as much as Trump wants, since the Fed as an institution is slow-moving and consensus-driven. The biggest danger isn't the manipulation of short-term rates—it's the manipulation of long-term rates, otherwise known as yield curve control. If the Fed caps long-term interest rates by buying an unlimited amount of bonds with printed money, it would be following in the footsteps of Weimar Germany. If Trump starts making noises about pegging the yield curve, be prepared for the worst.
There is a line of reasoning that says the Fed has done such an awful job that we would be better off without a Federal Reserve at all. When former Texas Rep. Ron Paul (R–Tex.) was recently asked who he preferred as Fed chairman, the longtime libertarian replied: "Nobody."
But the question then is: What replaces it? If we get a system where markets determine interest rates, we'll be better off. If we get a situation where presidents determine interest rates, we'll be much worse off.