At its current form, the Federal Reserve was formed by congress in 1913. The bill authorizing its creation was signed by President Woodrow Wilson. Before its creation, the US economy was plagued by extended periods of financial instability occasioned by high rate of inflation, bank runs, and credit scarcity. These problems lead to attempts of creating a central bank system, which failed. The Fed was formed to help stabilize the US economy by preventing bank failures and removing the risks of high inflation. To prevent political interference, the Fed was given its independence, a model that has been copied around the world.
During the 2016 election, Donald Trump was vocal about his opposition to the Fed monetary policy. His argument was that the Fed was supportive of president Obama and ‘rewarded’ him with low interest rates. He argued that tightening during his administration would lead the US to another recession.
As the president, Donald Trump removed Janet Yellen, who was appointed by President Obama. Her term was up for renewal in 2017. He replaced her with Jerome Powell, who was sworn in as the Fed chair earlier this year.
In recent weeks, the president has continued to express his frustrations with the Fed. A few weeks ago, he sent a tweet criticizing the interest rates being done by the Fed and this weekend, at a fundraising, he continued to attack the organization. He has also criticized the rate hikes for several other times in the past. In the president’s thinking, the Fed is working against his administration’s policies.
After his appointment, the Fed chair has remained supportive of Janet Yellen’s policies of gradually raising interest rates. This year, he is expected to do two more rate hikes; one in September and another in December. In response, the dollar has continued to strengthen as shown below.
The president’s statements are unprecedented and should not in any way affect the Federal Reserve. This is because, as mentioned, the Fed operates as an independent organization.
After the 2008 crisis, the Fed brought interest rates to zero with the aim of spurring growth. Other central banks around the world did the same. As the economy improved, the Fed started increasing rates. This was done to prevent the economy from overheating, which would increase inflation and ultimately a financial bubble. Interest rates hikes are also aimed at helping slow down the economy.
The final point is important because to many people, it does not make sense why a central bank would want to slow down the economy. The reality is, an economy that is growing very fast is dangerous to the country. For example, assume you have a lemonade stand that serves 50 people per week. In one month, the number of guests increase to 100, 200, 300, and 400 guests. To cope with the demand, you take a loan from a bank to finance your fast-growing company. Then, in the coming months, the numbers start to fall to the old-normal. You are then left with huge debts to pay, which may lead to a default.