Erosion of Fed independence would slow US economic growth and boost inflation over time

President Donald Trump has publicly urged the US Federal Reserve for months to significantly reduce interest rates to drive stronger economic growth and reduce federal debt service costs. Frustrated with the Fed’s cautious response, he has openly sought more influence over the central bank’s monetary policies: He threatened to fire the Fed chairman, tried to fire one of the Fed governors, and placed one of his economic advisers on the Fed board.

However, if he succeeds in pressing the Fed to cut rates more than it would otherwise, America would see slower growth through most of the next decade (see panel a of this PIIE Chart) and higher inflation through 2040 (see panel b), according to our paper, The International Economic Implications of a Second Trump Presidency, summarized here.

During the 2024 presidential campaign, we assessed the likely economic effects of Trump’s proposed policies by using an economic model, detailed in our paper. We started with a baseline projection for the US and other economies if Trump’s policies were not adopted. Then, we projected his policies’ effects, including the results of eroding the Fed’s political independence, measured as deviations from each baseline.

Candidate Trump did not specify how he would gain control over the Fed, but we assumed he would gain enough to cause the Fed in 2025 to rev up the economy’s growth to 2 percentage points faster than its potential growth rate. We found that in this scenario US economic growth surges in the first two years, followed by slower growth than otherwise for more than a decade. By 2040, cumulative real US GDP is $2.5 trillion less, in 2018 dollars, than if Trump had left the Fed alone.

We assumed the less independent Fed could cause the risk premium on holding US assets relative to assets of other countries to rise by 2 percentage points. We found that this heightened risk causes capital flows out of the US and into other countries, weakening US GDP growth and spurring several other economies.

In this scenario, US inflation is also worse through 2040, spiking in the first few years and settling around 2 percentage points higher than baseline. By 2040, prices across the US economy are roughly 41 percent higher than otherwise.

This PIIE Chart is adapted from The international economic implications of a second Trump presidency, by Warwick McKibbin, Megan Hogan, and Marcus Noland.