Chapter 1: What is the main topic discussed in this episode?
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Joining us now to extend the conversation, the former New York Fed President, Bill Dudley. Bill, welcome to the program. Extensive experience at the Federal Reserve inside that institution. How do you think they'll be responding to this this morning? They're going to be very unhappy because this is a real assault on the Federal Reserve's independence.
And as we know, central banks' independence is really important for good economic outcomes.
There's been a reason why we've been moving in the direction of greater central bank independence over the last four decades across the world, because central banks that have independence in terms of how they conduct monetary policy to achieve the objectives set for them by Congress and the administration do a better job in controlling inflation and keeping the economy on a stable path.
So this is assault on that. And I'm sort of surprised that the markets are so relaxed about this. Now, maybe that's because we don't know where this is going to go. We don't know whether Lisa Cook is going to be able to stay in office. It certainly looks like the bar to getting her out is quite high because it doesn't seem that the for cause would extend to the allegations against her.
But she certainly, at very minimum, deserves her day in court. Well, Bill, it seems like that is the system that is emerging, that we're understanding the contours of Fed independence from the courts, be it the most recent ruling that said other independent agencies could have their heads fired by Trump, but not necessarily the Fed without cause.
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Chapter 2: What is the significance of Fed independence in economic policy?
This may be defining, having the courts define what cause is. If you have a system where it's not encoded in law, but instead is being interpreted by the courts, what does that say about the fragility or the stability of Fed independence? Well, it sort of has to be interpreted by the courts because this is, but there's no precedence for this.
So we don't really know what the law is until the courts actually rule on it. So the courts have to decide, you know, what was the law intended to do? I think most people think that, you know, what Lisa Cook did does not represent for cause dismissal from her governorship, but it's up for the courts to adjudicate that.
So Bill, if we're in a scenario where it seems like we might be, that this is a Fed that wants to start to ease policy, that it wants to cut, but because of all these proceedings in the background, you get some real tension on the long end of the curve. What would the Fed do in that case, that it wants to cut, it wants to ease, but the markets do something different?
Well, I think the Fed will do what it thinks is appropriate to achieve its objectives on employment and inflation. And Paul certainly signaled it in his Jackson Hole remarks that he's worried about the downside risk to the labor market more than he's worried about the upside risk to inflation.
And so his view that monetary policy is currently restrictive, he basically sent a signal that it's highly likely the Fed's going to cut rates in September. And I don't think this changes any of that.
What does change is down the road when the Federal Reserve acts, when the Federal Reserve, if they cut rates at subsequent times, is that because they think that's an appropriate thing to do for the economy or because it's because they're under pressure from the Trump administration?
You know, putting a lot of pressure on the central bank is, in my mind, somewhat counterproductive because it basically causes people to start to wonder, is the central bank doing what is appropriate to achieve its objectives or is it caving into pressure from the administration? Bill, you've got great contacts. Do you sense that shift is already underway? No, I don't think so.
I think there is a case to cut rates in September. I'm not sure I would be in that camp. I'm not as convinced that monetary policy actually is restrictive today. And I am more worried that the rise in inflation caused by the pass-through of the tariffs could end up being more persistent than Powell does. That's a reasonable point of disagreement.
I think that if the Fed cuts rates in September, it's not a big event.
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Chapter 3: How does the Trump administration's actions affect the Federal Reserve?
The market certainly anticipates rate cuts over the next year. They expect the Fed eventually to cut rates back down to what they view as sort of a neutral federal funds rate of around 3% to 3.5%. Bill, out of interest, why are you more concerned about inflation?
In very simple terms, the Fed chair has basically come out and said he's not worried about upside risk to inflation because of the downside risk to employment. What makes you more concerned? Well, four years of being above your inflation objective. And, you know, every year you're above your inflation objective, that increases the risk that people start to view this as the steady state.
And then that starts to flow into wage settlements. And then it becomes very difficult to get rid of the inflation that's been embedded in the system at that point. Bloomberg Daybreak is your best way to get informed first thing in the morning, right in your podcast feed. Hi, I'm Karen Moscow. And I'm Nathan Hager.
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