06 September 2025

Noroozian:
The dismissal of Lisa Cook from the Federal Reserve on August 15th by President Trump has reignited the debate over the Fed’s independence. That’s why in this episode we decided to focus on the question of central bank independence and why it matters. To start, could you briefly explain how the institutional structure of the Federal Reserve works?

Hamzeh:
The Federal Reserve is governed by the Board of Governors, which consists of seven members appointed by the president and confirmed by the Senate. Each serves a 14-year non-renewable term, one of the longest in the U.S. government, precisely to shield them from political pressure. This long tenure means that no single administration can appoint a majority of the board — a key safeguard of independence.

In addition to the Board, there are 12 regional Federal Reserve Banks, which represent different parts of the country — from Boston to San Francisco. This regional structure was deliberately designed in 1913, when the Fed was created, to balance the interests of Washington, Wall Street, and Main Street. It ensured that monetary policy wouldn’t be dictated solely by the federal government or by large New York banks, which had dominated credit markets in the early 20th century.

The main policymaking body for interest rates is the Federal Open Market Committee (FOMC). It brings together the seven governors and five presidents from the regional Reserve Banks. The New York Fed president always has a permanent voting seat, since New York is where most open market operations — the buying and selling of government securities — take place. The other four votes rotate among the remaining eleven regional banks each year.

The FOMC sets a target range for the federal funds rate — the overnight rate at which banks lend to each other — and uses tools like open market operations and interest on reserves to keep it within that range.

The Fed’s independence comes from several layers. Financially, it is self-funded, meaning it does not depend on congressional appropriations but covers its expenses from its own operations, mainly interest on its vast portfolio of securities. Politically, governors cannot be dismissed by the president for policy disagreements, only for cause — an extremely high bar.

Historically, the Fed’s independence has been tested many times. In the 1960s and 70s, presidents from Johnson to Nixon pressured it to keep interest rates low, contributing to runaway inflation. The 1951 Treasury–Fed Accord is often cited as the defining moment that established modern central bank independence: it freed the Fed from having to finance government deficits by keeping bond yields artificially low after World War II.

That’s why the recent dismissal of Lisa Cook has raised alarms. Trump’s earlier public attacks on the Fed were seen as verbal pressure. But removing a sitting governor breaks new ground and could be viewed as an attempt to reassert presidential control over monetary policy — something the U.S. system has deliberately tried to avoid for more than seven decades.  

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Noroozian:
You mentioned that the Federal Reserve’s independence has deep historical roots and legal protections. How does this structure compare with other major central banks, such as the European Central Bank or the Bank of England? Are they equally independent, or does the Fed stand out in some way?

Hamzeh:
That’s a great question, because central bank independence can take quite different forms across countries. The Federal Reserve is often described as “operationally independent but politically accountable.” It operates under a congressional mandate — to ensure price stability and maximum employment — but Congress and the president cannot directly dictate how it fulfils that mandate.

In the United States, this balance between independence and accountability is uniquely American: the Fed must regularly report to Congress and its chair testifies twice a year, yet day-to-day decisions on interest rates are made without political interference. This mix evolved gradually, especially after the 1951 Treasury–Fed Accord, and it has proven remarkably resilient.

By contrast, the European Central Bank (ECB) was designed to be even more insulated from politics. Its independence is written directly into the EU treaties, meaning that neither national governments nor EU institutions can instruct it. The ECB’s sole primary objective is price stability — there’s no dual mandate like the Fed’s. That narrow focus makes it one of the most independent central banks in the world, but also sometimes less flexible when unemployment rises, because it doesn’t explicitly target jobs.

The Bank of England sits somewhere in between. It gained operational independence only in 1997, when the British government gave it full control over setting interest rates. However, unlike the Fed or the ECB, the UK Treasury still defines the inflation target — currently 2 percent — and can, in theory, override the Bank in exceptional circumstances.

So, in short, while all three major central banks are independent, they differ in how that independence is structured. The ECB has the strongest legal insulation; the Bank of England has the clearest political oversight; and the Federal Reserve strikes a middle path — powerful but still deeply tied to democratic accountability.

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Noroozian:
Let’s talk about why central bank independence is so important. Economists always stress that monetary policy should be insulated from political influence — but what’s the theoretical reasoning behind that?

Hamzeh:
The theoretical case for central bank independence really took shape in the aftermath of the high inflation of the 1970s. Two landmark papers had a huge influence on how economists and policymakers thought about this issue: Kydland and Prescott (1977) and Barro and Gordon (1983).

Their basic idea was that monetary policy can suffer from what economists call time inconsistency. In simple terms, a central bank might initially commit to low inflation to keep expectations anchored. But once inflation expectations fall, the temptation arises — especially before elections or in politically sensitive periods — to lower interest rates, stimulate demand, and temporarily boost growth and employment.

The problem is that rational economic agents anticipate this behaviour. If they believe the central bank might abandon its low-inflation promise for short-term political gain, they’ll build higher inflation expectations into wages and prices from the start. The result is that inflation expectations rise, credibility collapses, and monetary policy loses its effectiveness.

That’s where independence becomes critical. By separating the central bank from direct government control, policymakers remove that political incentive to “cheat” for short-term growth. Independence builds credibility — people and markets start to believe that the central bank will stick to its inflation target even when it’s politically costly. And that credibility itself helps to keep inflation expectations — and therefore actual inflation — low.

In this sense, the independence of the Federal Reserve isn’t just an institutional detail; it’s part of the mechanism that keeps inflation stable. If that independence comes under doubt, inflation expectations can rise simply because people lose confidence that the Fed will act autonomously.

That’s why the recent pressure on the Fed — for example, Trump’s repeated calls for lower interest rates and his attempt to dismiss a sitting governor — could easily backfire. If markets start to believe that monetary policy is being shaped by political motives, inflation expectations could move higher. Ironically, that would force the Fed to keep rates higher for longer in the future to restore its credibility — the exact opposite of what political leaders might want.

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Noroozian:
Setting aside Trump’s political pressure, what has been the Federal Reserve’s own policy stance recently? After all, U.S. interest rates are still quite high — which makes government debt more expensive to service and could weigh on both employment and growth.

Hamzeh:
That’s right. After the pandemic, the Federal Reserve sharply raised interest rates to rein in inflation. During the pandemic years, the federal funds rate was below 1 percent. But starting in March 2022, the Fed began its most aggressive tightening cycle in decades. By September 2023, the target range had climbed to around 5.25 to 5.5 percent, the highest level since before the 2008 financial crisis.

Now, as of September 2025, the effective rate is about 4.3 percent, still historically high but down from last year’s peak. The Fed has already cut rates twice this year — in March and again in July — signalling a gradual pivot toward easier policy. The logic is that today’s policy rate remains well above the so-called neutral rate — the level consistent with stable inflation and full employment. In other words, monetary policy is still restrictive.

That restrictiveness has side effects. High rates increase borrowing costs for households and firms and make debt servicing more expensive for the federal government. There’s also growing concern that if rates stay high for too long, unemployment could rise. Indeed, job growth has slowed noticeably since early summer.

At the same time, inflation is not fully back to target. The Fed’s preferred measure — the Personal Consumption Expenditures (PCE) price index — stood at 2.6 percent in July, slightly above the Fed’s 2 percent goal. The August data, due soon, are expected to show a similar reading. So the Fed finds itself in a delicate balancing act: inflation is close enough to target to justify some easing, but not low enough to declare victory.

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Noroozian:
Given that inflation is still above the Fed’s target — and tariffs could push it even higher — why would the Federal Reserve still consider lowering interest rates?

Hamzeh:
One reason lies in the labour market. Conditions there have clearly weakened. Over the past four months, non-farm payrolls have grown by fewer than 50,000 jobs per month. Outside of recessions, we’ve almost never seen such a sluggish pace of job creation in the U.S. It doesn’t necessarily mean a recession is coming, but it does signal that the labour market is softening — and the Fed cannot ignore that.

Unlike the European Central Bank, which has a single mandate focused on price stability, the Federal Reserve operates under a dual mandate: price stability and maximum employment. So when job growth slows this sharply, it naturally strengthens the case for rate cuts, even if inflation hasn’t fully returned to target.

Now, you’re absolutely right about tariffs. Goldman Sachs estimates that by December 2025, Trump’s tariffs could add roughly 0.8 percentage points to U.S. inflation. According to the Taylor rule, which has long guided central-bank behaviour, whenever inflation rises above the target, the nominal interest rate should increase by more than the rise in inflation. That’s because to bring inflation back down, real (inflation-adjusted) interest rates must rise, not just keep pace.

So, following that rule strictly, the Fed would need to raise rates by more than 0.8 percentage points in response to those tariff-driven price pressures. But in practice, that’s not how modern central banks behave anymore.

During the late 1980s and early 1990s, policymakers followed the Taylor rule quite rigidly, reacting aggressively to inflation shocks. But since the late 1990s, most central banks — including the Fed — have become far more flexible. They tend to look through short-term shocks, allowing temporary price increases to fade rather than immediately tightening policy.

And here’s the crucial point: the Fed’s ability to do that — to tolerate temporary price bumps without losing control of inflation — depends entirely on its credibility. When people trust that the Fed will ultimately keep inflation under control, their inflation expectations stay anchored. That credibility allows the central bank to respond more gradually instead of overreacting.

This is exactly what’s happening with tariffs. Many policymakers, including Chris Waller, one of the Fed governors and a possible future chair, argue that the inflationary effect of tariffs is transitory — a one-off adjustment in prices rather than a persistent trend. As long as inflation expectations remain stable, there’s no need for the Fed to counter every temporary shock with higher rates.

So, in essence, the Fed’s cautious shift toward easing reflects two things: weakening labour-market data and confidence in its own credibility. It trusts that it can support employment without reigniting inflation — as long as the public continues to believe that the Fed will do whatever it takes if inflation truly starts to rise again.

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Noroozian:
One concern often raised by analysts is that lowering interest rates could worsen the U.S. government’s already high debt burden. Some even argue that this debt pressure is one of the main reasons behind Trump’s push for lower rates. How do you see that?

Hamzeh:
That’s a fair point. U.S. public debt now exceeds 100 percent of GDP, and the federal budget deficit this year is projected to remain above 6 percent of GDP. Under normal economic conditions — when the economy isn’t in recession — a large fiscal deficit would usually call for a tighter monetary policy to counter inflationary pressures.

You can also think about it through the Taylor rule framework. When government borrowing is high, public debt absorbs a larger share of national savings. That pushes up the neutral interest rate — the rate consistent with full employment and stable inflation — meaning the central bank would need to keep its policy rate higher as well.

However, those who are less alarmed about U.S. debt argue that a big part of the deficit reflects demographic ageing. An ageing population raises public spending, especially on healthcare and pensions, but it also tends to increase demand for safe assets such as U.S. Treasury bonds. In other words, while ageing drives government borrowing up, it simultaneously boosts the appetite for holding government debt — effectively lowering its financing cost.

Some research, such as that by Ludwig Straub of Harvard University, estimates that this demographic shift could allow the U.S. government to sustain debt levels of up to 250 percent of GDP by the end of this century, without triggering a fiscal crisis. The logic is that as the population ages, more savings flow into government bonds, offsetting the rise in borrowing needs.

Of course, there’s plenty of debate about the exact numbers, but the broader idea is widely accepted: population ageing can make high debt more sustainable over the long term. For a country like the United States — with deep financial markets and a global reserve currency — that’s a significant cushion.

Coming back to the Fed, if ageing truly raises household savings and global demand for Treasuries, it somewhat reduces the urgency for the central bank to worry about the government’s fiscal position in the short term. That said, this is a long-run adjustment, not a short-term reality the Fed can safely rely on today.

The real risk is that high debt only becomes a problem when conditions turn unfavourable — for example, during a recession, when fiscal space is needed for stimulus, or during periods of high inflation, when rising interest rates make debt servicing far more expensive. In those moments, the burden of accumulated debt can limit both fiscal and monetary flexibility. So while the U.S. can live with high debt for now, it’s a vulnerability that could resurface sharply when the next downturn or inflation spike arrives.

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Noroozian:
So, to sum up, it sounds like the key takeaway from what you’re saying is that monetary policy is a complex task that needs to remain independent from political influence. Government interference in central banking, by undermining that independence, can weaken both the credibility and the effectiveness of monetary policy.

Hamzeh:
Exactly. The main problem with political interference is that once the credibility of the central bank is damaged — that is, once people stop viewing it as an independent institution committed to controlling inflation — the entire system of expectations begins to unravel. When economic agents lose trust in the central bank, even small shocks can lead to rising inflation expectations, and those expectations can quickly turn into actual inflation.

If firms believe prices will rise, they raise their own prices pre-emptively. Workers, expecting higher living costs, demand higher wages. In that way, inflation expectations themselves become self-fulfilling.

That’s precisely why the independence and credibility of a central bank matter so much. They anchor expectations. They send a clear signal to households, firms, and markets that monetary policy remains firmly focused on price stability — that inflation will be brought under control no matter what. When that trust is intact, even temporary shocks fade away without spiralling into persistent inflation.

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Noroozian:
Before we wrap up, let’s bring the discussion home. What lessons can Iran draw from this global shift toward central bank independence?

Hamzeh:
Since the 1980s, most economies around the world have moved toward granting greater independence to their central banks — separating monetary policy from day-to-day political control. The results have been quite clear: except for a brief period after the pandemic, inflation has largely ceased to be a major concern in most advanced economies.

Unfortunately, that’s not the path Iran has taken. The head of Iran’s central bank is still appointed — and can easily be dismissed — by the president. That lack of independence means the central bank essentially operates as an extension of the government. Monetary policy becomes a tool to serve fiscal needs rather than an independent instrument for price stability. Central bank resources are often used to finance government spending and cover budget deficits.

Because Iranian government bonds are not attractive to investors, public debt is effectively financed through money creation, which fuels inflation. And inflation, as we know, acts like a regressive tax — it hurts wage earners and the lower-income segments of society the most.

The outcome is what we’ve seen for decades: chronic, structural inflation deeply embedded in the economy. One of the most critical reforms Iran needs is to separate monetary policy from fiscal policy — to make the central bank an institution whose sole mandate is price stability.

If Iran truly wants to bring down inflation in a lasting way, the solution isn’t to fight “gold traders” or “currency speculators.” It’s to grant the central bank real independence — and with it, the credibility needed to anchor expectations and stabilise prices.