ECB's Lagarde: Fed's Independence Still Under Threat

ECB's Lagarde: Fed's Independence Still Under Threat

European Central Bank President Christine Lagarde said Thursday that the independence of the Federal Reserve is still at risk, and safeguarding it will depend on continued support from voters and legislators.

Trump's Pressure on the Fed

In a speech to central bankers from French-speaking countries delivered in Cambodia, Lagarde said the capacity of policymakers to make decisions that might displease the government is under increasing threat. During his second term, President Trump has attempted, more systematically than any predecessor, to bend the Federal Reserve to his will, frequently criticizing its leadership for not lowering the key interest rate more rapidly.

Support for Independence Key

Central bankers have welcomed the appointment of Kevin Warsh as the Fed's new chair, but Lagarde said the struggle isn't over, and that support for independence from voters and legislators remains key. "The matter is not settled, but we can clearly see the mechanism at play: where credibility exists, defending independence does not fall on the central bank's shoulders alone," she said.

Fighting Inflation and Costs

Lagarde said independence can be secured by focusing narrowly on inflation as the key objective and acting to contain price rises even when there is an economic cost to doing so. "Price stability must remain the primary objective and it must be defended even if there is a real, immediate cost," she said. Although Trump chose Warsh to deliver rate cuts, he takes the helm at a time when inflation has accelerated as a result of the higher energy prices caused by the conflict in the Middle East. Lagarde said policymakers must also be seen to make decisions that clearly connect with the goal of taming inflation if they are to retain support from households.

Threats from Public Debt and Financial Fragility

Lagarde said independence is also being put at risk by rising levels of government debt, since a central bank raising its key rate to tackle inflation can impose additional interest costs on already wide budget deficits. "The legal frameworks cannot safeguard independence when fiscal trajectories become unsustainable," she said. A fragile financial system can present a central bank with a similar dilemma. If banks and other financial institutions have borrowed too much and don't have enough capital, a rise in interest rates can place them in peril. While regulations were tightened in the wake of the global financial crisis, they have been loosened in some parts of the world over recent years. "When fragility in parts of the system make each interest rate change potentially destabilizing, the central bank sees its room for maneuver curtailed," Lagarde said. The ECB left its key interest rate unchanged at 2% in April, but investors expect it to raise borrowing costs next month despite signs that the near-stagnant eurozone economy is weakening as energy costs rise.