European Central Bank President Christine Lagarde stated on Thursday that the independence of the U.S. Federal Reserve remains under significant threat, emphasizing that preserving it requires continuous support from voters and legislators.
Speaking to central bank officials from French-speaking nations in Cambodia, Lagarde noted that policymakers face increasing constraints in making potentially unpopular decisions, as multiple shocks drive up prices while simultaneously hampering economic growth.
During his potential second presidential term, Donald Trump has more systematically than any of his predecessors sought to pressure the Federal Reserve to align with his preferences, frequently criticizing its leadership for not lowering benchmark interest rates more quickly.
While central banking circles have acknowledged Kevin Warsh's potential appointment as the new Fed Chair, Lagarde argued that the battle to defend its independence is far from over, and support from the electorate and legislative bodies remains crucial.
"The issue is not yet settled, but the logic is clear: as long as a central bank maintains credibility, safeguarding its independence is no longer a solo endeavor for the institution itself," she said.
The eurozone's top central banker pointed out that to preserve central bank independence, stabilizing inflation must remain the core objective, with a firm commitment to curbing price increases even if tightening policies exacts an economic toll.
"Price stability must be the primary goal, and this line must be held even at the cost of real, immediate losses," she stated.
Trump's nomination of Warsh as Fed Chair was intended to advance interest rate cuts, but upon taking office, Warsh would confront heightened local inflation driven by rising energy prices due to tensions in the Middle East.
Lagarde emphasized that to maintain public support, all policy decisions must be clearly framed around the objective of containing inflation.
"Whether inflation expectations remain stable depends on the public's belief that the central bank will follow through on its commitments," she said. "Credibility is built here, and it is also most easily lost here—once words and actions diverge, credibility quickly erodes."
Lagarde also highlighted that high government debt poses another threat to central bank independence. Raising benchmark interest rates to combat inflation increases the interest costs on already elevated fiscal deficits.
"If the fiscal trajectory becomes unsustainable, even a legal framework cannot guarantee the central bank's independence," she noted.
A fragile financial system places central banks in a similar dilemma. If banks and other financial institutions are over-leveraged and undercapitalized, interest rate hikes could endanger them. Although financial regulations were tightened globally after the financial crisis, some regions have recently relaxed these rules again.
"When vulnerabilities exist in parts of the financial system, every interest rate adjustment can trigger market turbulence, thereby limiting the central bank's room for policy maneuver," Lagarde said.
The European Central Bank kept its benchmark interest rate unchanged at 2% in April. Despite signs that the already nearly stagnant eurozone economy is weakening further due to rising energy prices, investors still expect the ECB to raise interest rates next month.
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