Scapegoating The Fed Chair For Interest Rates Won’t Fix The Economy

A few weeks ago, Vice President J.D. Vance promoted a free-market-friendly approach to regulating cryptocurrency. He said that the administration wanted a “common sense” framework rather than a “dictatorial government” to ensure that “the laws of economics” would do their thing.

Yet, the administration has shunned free market principles pretty much everywhere else, from trade policy to corporate acquisitions. On monetary policy and interest rates, the administration has displayed both a bizarre propensity to browbeat its own government officials and a complete lack of economic understanding.

Aside from President Trump’s own name-calling and rate-cut demands, Commerce Secretary Howard Lutnick complained that “the greatest country in the world” shouldn’t have to “suffer with the highest interest rates of any first class country.” The director of the Federal Housing Finance Agency followed up with “Jerome Powell is doing a great injustice to this Country” and “Mortgage rates, and interest rates, need to come down.”

There’s much to critique here, but for clarity: I’m no fan of central banking, and I don’t think the United States should have created one in 1913. But it did, and now “getting rid of the Fed” essentially means getting rid of the U.S. dollar. It’s important to debate optimal policy under this arrangement, but doing so is impossible without understanding exactly what the Fed does and doesn’t do.

The Fed Does Not “Set Interest Rates”

First and foremost: The Fed does not control everything. The central bank’s policies are a main determinant of inflation, but fiscal policy also affects inflation. So do supply constraints and other factors out of the Fed’s control. As a result, the Fed does not have precise control of inflation, especially in the short run. And even though virtually every news cycle suggests otherwise, the Fed does not have precise control over interest rates.

The Fed does set the rate of interest it pays on reserves, but that’s just one interest rate, and it’s a rate that didn’t exist prior to 2008. Theoretically, the Fed sets this rate to influence the federal funds rate, which, in turn, can influence other borrowing costs. It’s always been the case, though, that the Fed only influences the FFR. That is, it sets a target FFR and tries to affect short-term credit markets so that the FFR stays close to the target.

But the effective FFR was (prior to 2008) set by private banks’ borrowing and lending of reserves, and it frequently moved away from the target. In other words, even the Fed’s influence over the FFR has always been indirect and imperfect. Moreover, the Fed’s decision to flood the market with reserves has kept the federal funds market sidelined since 2008.

Interest Rates Obey the Laws of Economics

Moreover, while many interest rates tend to be correlated, the relationship between the FFR and “interest rates” is less precise than one might think. As surprising as this imprecise relationship may be, the Fed simply can’t ignore the pesky laws of economics.

Let’s say, just for kicks, that the folks at the Fed really want to “decrease interest rates.” So, they ignore the optimal (equilibrium) value of the FFR and do all they possibly can to decrease the FFR. If, however, the equilibrium value is higher than the Fed’s target, then the Fed’s artificially loose credit conditions would result in higher inflation. And higher inflation would, of course, result in higher borrowing rates, most likely for both privately and publicly issued debt, as people required additional compensation for risk.

That is, the laws of economics would beat the Fed.

Far too often, Fed critics forget this rule. While the recent attacks on Powell are not quite the norm, many people regularly blame the Fed for artificially high—or low—interest rates as if the Fed sets all the borrowing rates in the economy. But that’s just not how things work.

Among other problems, this singular focus on the Fed’s supposed rate setting absolves the elected officials who directly control the government’s borrowing and spending habits. And that’s a huge mistake.

Fiscal Problems Affect Interest Rates on Treasuries

As the chart below shows, the year-to-year change in federal debt skyrocketed under Trump, as did the share of public debt held by the Fed. In total, under the first Trump administration, federal debt increased by approximately $8.3 trillion. It then increased $7.7 trillion during the Biden administration. (The share held by the Fed declined during most of the Biden administration.) At the very least, the COVID crisis proved that large deficit-financed expenditures can induce inflation and make monetary policy goals difficult to achieve.

While the Fed did purchase more U.S. debt than normal during the COVID-19 spending spree, it really didn’t have to because demand for U.S. Treasuries was so strong—pretty much everyone views U.S. Treasuries as the safest of all the safe assets. Still, even with relatively strong demand, there are limits to what the Fed can achieve with buying Treasury debt.

If, for instance, the Fed started buying all newly issued Treasury debt to “set interest rates,” people would (correctly) view the United States as a banana republic. Rates would undoubtedly soar, and the central bank would lose all credibility as an institution that was sticking to its price level mandate.

This example is quite extreme, but the limit doesn’t have to be so dramatic. The Japanese government, for instance, is nervously contemplating a buyback program to “absorb some of the over-abundant supply” of its long-term debt. Government officials are hesitant to start the program, though, because demand for its long-term debt has declined.

Perhaps this decline is not so surprising because the Bank of Japan already holds about half of Japan’s public debt and the country’s debt-to-GDP ratio is 260 percent. However, the United States, with a debt-to-GDP ratio currently at 120 percent and headed toward 200 percent, is not fully immune from the same sort of decline.

Lower Demand for Treasuries Can Raise Interest Rates

Regardless of the reason, a decline in demand for Treasuries can affect Treasury rates. Recently, for example, less-than-stellar demand pushed rates higher during some recent Treasury auctions, for both 30-year and 2-year Treasuries. The 5-year note showed “average” demand, and the 7-year note showed “above average” demand.

These results provide just one more example that, in practice, the Fed does not just “set interest rates.” And as my colleague pointed out in October 2024, several different interest rates “increased since the Fed’s [target] rate cut.”

In September 2024, the Fed cut its target rate 50 basis points. It followed up in November and December with another 25-basis-point cut, and it’s held the target there ever since. Meanwhile, between September 2024 and January 2025, the 30-year Treasury rate went from 3.94 percent to 4.98 percent. It fell in January but started rising again in April. (The same pattern is seen in the 10-year rates.)

In the end, all the heightened interest in the Fed should make it easier to improve monetary policy so that it disrupts individuals’ economic decisions as little as possible. More Americans will surely prosper when the laws of economics are allowed to work best.

But if Congress and the administration continue to focus on scapegoating the Fed instead of fixing the nation’s fiscal and economic policies, they will not improve anything.

Jerome Famularo provided research assistance for this article.