As Trump stirs up considerable turbulence, the world has entered a historic turning point, making it impossible for the Federal Reserve (Fed) to remain detached as its every move is closely watched. Can the Fed exert a stabilizing force at this critical juncture and maintain its independent, objective, and professional image? If ever there were a time for such resolve, it is now.
Preserving central bank independence is the Fed’s top priority. Trump relentlessly pushes the Fed to cut rates and even threatens to oust Chair Powell with harsh words. This predictable Trump tactic still shocked Wall Street investors. The stock market crashed in response. Within days, Trump briefly retracted his call to replace Powell, but he continues to press for rate cuts. Trump seems intent on blaming Powell’s delay in cutting rates for economic weakness. Facing this charge, the Fed must clearly explain the true state of the economy and precisely guide its policy direction and intensity. Powell stated the financial market still operates within a normal system. Rates will hold steady for now to monitor economic trends. This first test displayed a calm, independent stance. Yet subsequent challenges remain formidable.
Inflation and economic slowdown loom as dual threats. The Fed cannot evade this issue. When inflation threatens, central banks often raise rates to reduce the money supply and counter rising prices. When the economy slows, central banks tend to lower interest rates to encourage lending and stimulate investment and production. Over the years, the Federal Reserve has employed various monetary policy tools, including interest rate adjustments, open market operations, purchases of government bonds and securities, quantitative easing, special lending programs, and modifications to bank reserve requirements, all of which have expanded or contracted the Scale of its balance sheet.
The balance sheet-to-GDP ratio fluctuated significantly. In Q4 2008, it was just 6.07%. After the financial crisis, it climbed to 25.59% by Q3 2014. As the economy improved, the ratio fell. Following massive fiscal spending during the 2020 pandemic, it peaked at 36.98% in Q4 2021. Each major balance sheet expansion occurred during economic stagnation, contributing to the bitter inflation surge of 2022.
The Fed targets a 2% long-term average inflation rate. Powell’s April 4 speech noted the 12-month PCE inflation rate through February 2025 was 2.5%, with core PCE at 2.8%. U.S. GDP grew 2.1% in 2024, projected to slow to 1.7% in 2025. The Fed’s April 24 Beige Book indicated signs of stagflation emerging. The IMF’s April 22 “World Economic Outlook” reported global growth at 3.3% for 2024, revised down to 2.8% for 2025, stating, “The global economic system, operational for 80 years, is resetting.”
Multiple variables add further pressure to the Fed’s decisions. U.S. public debt has hit $36 trillion. The debt-to-GDP ratio rose from 51.97% in Q1 1990 to 121.85% in Q4 2024. Annual interest payments are staggering, fueling calls for rate cuts. Trump’s tariff policies have created increasingly tangled complications, triggering international backlash and reports of large-scale U.S. Treasury bond sell-offs, which pose risks of potential downgrades to U.S. bond ratings. Additionally, the Trump administration seeks to reduce the trade deficit through dollar depreciation to boost exports, while loudly demanding rate cuts to lower dollar demand and achieve devaluation. These factors pull the Fed’s policy decisions in conflicting directions.
Notably, the effects of monetary policy are not immediate, often lagging by months to years. With inflation expectations already elevated, loose monetary policy could amplify inflation over time, potentially causing uncontrollable damage. Therefore, the timing of policy measures is critical. The battered market looks to the Fed as a lighthouse, guiding with a beacon in the dark. As the hourglass runs, the Fed must weigh all angles and trade-offs and choose wisely with no room for error.
Author: Ya-Hui Yang, Advisory Committee Member, Chung-Hua Institution for Economic Research
Source: Commercial Times, May 8, 2025 04:10 PM