Why Central Bank Independence Matters

On Friday, January 9, 2026, the US Department of Justice took the unprecedented step of serving the Federal Reserve with grand jury subpoenas. This action followed an unrelenting campaign External link. by the US administration to pressure the Federal Reserve Board to cut interest rates, regardless of whether it was warranted by the developments in the US economy. Chair Powell released an equally unprecedented statement External link. the following Sunday, calling out the grand jury subpoenas for what they are—the most recent escalation in the political attacks on the Federal Reserve’s independence.

Given the success of central bank independence, it’s easy to forget why it’s so important. Indeed, while it’s taken for granted today, the conduct of monetary policy wasn’t always this way. Central banks were increasingly granted independence following the surging inflation that started in the late 1960s and peaked in the early 1980s. Political interference in interest rate setting was determined to be a primary culprit of this inflation, with politicians putting their own short‑term electoral interests before the long‑term economic interests of their respective countries’ economies. Aggressive interest rate hikes, first by the Federal Reserve External link. and followed by other central banks, caused overheated economies to contract and inflation to slow rapidly. Further innovations ultimately led to the inflation‑targeting frameworks used the world over today. Beginning in the early 1990s, these helped to keep inflation at or around central banks’ targets for decades until supply chain disruptions pushed prices higher following the COVID‑19 pandemic.

Key to the success of inflation targeting is the credibility of central banks. Price setters in the economy, whether businesses or workers, need to have confidence that inflation will be close to the central bank’s target over the duration of a contract. Otherwise, it is a “choose your own adventure” of price increases baked into contracts to mitigate the risk of prices or compensation declining in real terms. This type of behaviour contributed to the wage‑push inflation of the 1970s.

They say that credibility is hard to earn but easy to lose. And the credibility of central banks has been earned over decades of communicating a consistent message and adjusting policy with the intent of achieving a stated goal, typically inflation at around 2% in advanced economies. Recent research External link. from the European Central Bank has confirmed that over the past 50 years, “central banks that are shielded from government control are able to pursue more credible monetary policies and are therefore better at keeping prices stable.” In the context of the US specifically, research External link. has consistently verified that past political pressure on the Federal Reserve to ease monetary policy increased the price level strongly and persistently, didn’t lead to positive effects on real economic activity and had a stronger effect on inflation expectations.

Partisan attacks on, and appointments to, the Federal Reserve Board in the hope of short‑term political gain risk eroding the credibility of the most important central bank on earth. These are the types of actions taken by countries like Russia, Turkey, Argentina, Venezuela and Zimbabwe—hardly beacons of institutional strength. According to the World Bank, the strength of US institutions has been heading in the wrong direction for decades. The Federal Reserve has been able to avoid much of this institutional decay due to bipartisan recognition of its central importance to the US and global economies and financial systems.

So, why the aggressive attacks on Fed independence now? The US is going through a period of highly concentrated power in the White House accompanied by large expected US government deficits. This has become a recipe for fiscal dominance, which former Federal Reserve Chair Janet Yellen defined in a recent speech External link. as “a situation where the government’s fiscal position—its deficits and debt—puts such pressure on its financing needs that monetary policy becomes subordinate to those needs.” In a world of fiscal dominance, easing the government’s financing burden becomes the priority while the mandate of price stability and full employment are secondary. As a result, fiscal dominance typically results in higher and more volatile inflation or politically‑driven business cycles. Inflation expectations may become unanchored as a consequence. Term premia and borrowing costs are also likely to rise as, according to former Fed Chair Yellen, “investors become concerned that the government will rely on inflation or financial repression to manage its debt.”

For all these reasons, fiscal dominance must be avoided, particularly in the US. Unfortunately, the US administration seems largely oblivious to the lessons of history. And while markets look to have shaken off this latest abuse of power as just more noise out of Washington, record gold prices suggest not all investors are sanguine on the outlook. Indeed, even if the US economy gets a boost in the near term thanks to needlessly low short‑term interest rates, in the long run, everyone loses.