Understanding the Federal Reserve and Politics: A Guide for Investors

Chris
July 28, 2025

Recent disagreements between the White House and the Federal Reserve have highlighted questions about Fed independence. This happens because elected officials and the Fed often have different goals and motivations.

For example, the President and Congress usually want lower interest rates to boost economic growth and help pay for government spending. However, the Fed might need to make tough decisions about issues like rising prices (inflation) and keeping the financial system stable, thinking about what’s best for the long run.

The Fed has both supporters and critics, and many books have been written about the successes and mistakes of different Fed leaders. Even so, Fed independence has been a key part of our financial system for many decades. Today, much of the debate focuses on whether the President can legally remove a sitting Fed chair, what would happen if that occurred, and who might be chosen as a replacement.

But what really matters for investors is whether monetary policy (decisions about interest rates and money supply) stays appropriate and the economy remains stable. No matter what the administration decides to do, Jerome Powell’s time as Fed Chair will end by May 2026. What should investors think about regarding the Fed in the coming years?

Fed independence has changed over time

The chart shows the nine Fed chairs who have served since 1948. Almost all of them worked under presidents from both political parties, including being renominated by different presidents. For instance, Jerome Powell was first chosen by President Trump in 2017, and then confirmed for a second term under President Biden. This chart also shows that the economy has grown under different Fed chairs chosen by presidents from both parties.

The idea of Fed independence is often assumed, so it helps to understand its background. As the country’s central bank, the Fed sets monetary policy (decisions about interest rates and money supply) and watches over the stability of the financial system. Independence means the Fed is free from political pressure, allowing it to make decisions based only on what’s best for the economy and financial system.

This independence developed gradually. The Fed wasn’t created by the Constitution, but by the Federal Reserve Act of 1913 that Congress passed. The Fed has a dual mandate (two main goals) that has also changed over time, and is often understood as: a) keeping unemployment low, and b) keeping inflation at about 2%. So, how monetary policy works today has been shaped by historical economic events including recessions and periods of high inflation.

After the Great Depression, the Banking Act of 1935 reorganized the Fed, giving more power to the Board of Governors and removing the Treasury Secretary from the Board to reduce political influence. During World War II, the Fed gave up some independence by keeping interest rates low to help pay for the war. This continued until the 1951 Treasury-Fed Accord, which is widely seen as restoring Fed independence by ending its requirement to support government bond prices.

The inflation and policy situation remains complicated

The best comparison to today’s situation might be the 1970s and early 1980s. Before the 1972 election, President Nixon wanted easy monetary policy (low interest rates) to help his campaign. Fed Chair Arthur Burns, who had been Nixon’s economic advisor, agreed to this by making monetary policy looser, which economists believe helped cause the inflation problems of the next decade.¹

It wasn’t until the early 1980s, under Paul Volcker, that the Fed regained control of inflation by causing a recession. While most economists agree this ended the “stagflation” (high inflation with slow growth) of that time, it created political challenges. In his memoir, Volcker wrote about pressure from the Reagan administration not to raise rates before an election.²

In many ways, today’s economic situation is similar to the 1970s because there are tensions between keeping higher rates to make sure inflation gets better, and lowering rates to boost growth. While inflation has been moving closer to the Fed’s 2% target, headline CPI (Consumer Price Index, which measures inflation) is still at 2.7% and core inflation is at 2.9% according to the latest report. Also, the Fed is taking a “wait-and-see” approach on whether tariffs will raise prices for consumers.

One way to understand this challenge is through the money supply, shown in the chart above. The money supply, which is managed by the Fed, typically grows steadily, supporting both stable growth and inflation. During crisis periods, such as in 2020, the money supply is used to support the economy. However, money supply growth has been flat in recent years as policymakers focused on fighting inflation. Naturally, this can conflict with what some elected officials might prefer.

The Fed is still expected to lower rates

Politics aside, the Fed is expected to lower rates more this year. It has paused after several cuts in late 2024 due to uncertainty around tariffs. The reality is that Fed policy exists to support long-term growth trends. When the economy is getting stronger, the Fed’s job is to make sure it doesn’t get too hot – sometimes described as “taking the punch bowl away.” When the economy is weak, lower rates may be needed to restart growth.

This balancing act is difficult, even in the best of times. Looking back, the Fed is often accused of being “behind the curve” (acting too late). For instance, Alan Greenspan, who served as Fed Chair for nearly 20 years, didn’t properly respond to the housing bubble forming at the end of his time in office. More recently, some argue that the Fed raised rates too slowly in 2022 when there was already clear evidence of inflation.

What matters for investors and their portfolios is not to debate what the Fed should or shouldn’t have done. Instead, it’s to respond properly to the current investment environment with a long-term plan. History shows that changes in Fed leadership and shifts in policy can create uncertainty, but markets have performed well despite these challenges.

The bottom line? The market and economy have performed well under many different monetary policy and political environments. Maintaining a long-term plan that can handle this uncertainty is still the best way to reach financial goals.

1. https://www.aeaweb.org/articles?id=10.1257/jep.20.4.177

2. Volcker, P. A. (2018). Keeping At It: The Quest for Sound Money and Good Government

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