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♪ ♪ KATKO: Welcome, America, to "Balancing Act," the show that aims to tame the political circus of two-party politics.

I'm John Katko.

This week, our interest is in the Federal Reserve.

What exactly is it?

How do we protect its independence, and how does it affect our daily lives?

In the center ring, Former Fed Chair Donald Kohn will help answer those questions for us.

Then Congressman Juan Vargas and former Chairman of the House Financial Services Committee, Patrick McHenry, take to the trapeze to discuss how to protect the Fed from political influence.

Plus, I'll give you my take.

We'll find out what's happening Next week in Washington with Bloomberg's Laura Davidson.

So let's get started on the tightrope.

♪ ♪ At the turn of the 20th century, America found itself in a constant cycle of repeated economic recession.

The country lacked a collective financial system and a central bank to fortify the economy in moments of instability.

And while the concept of a central bank had long been popular in Europe, many in the U.S.

feared such a powerful central bank would exert too much control and be swayed by political interests.

But by 1913, lawmakers and industry leaders knew there needed to be a safer, more stable financial foundation for the nation, and the Federal Reserve or the Fed was born.

The Fed's responsibility spanned four main areas conducting monetary policy, supervising banks, safeguarding financial stability and providing key financial services like payments and currency.

In practice, that usually means raising or lowering interest rates, adjusting the supply of money and stepping in when markets seize up.

At the top of the Fed sits the Board of Governors in Washington, seven members appointed by the President and confirmed by the Senate with 14-year terms each.

Across the country, 12 regional banks keep an eye on local economies and serve banks in their districts.

Then there is a Federal Open Market Committee, which unites those two arms to set national monetary policy.

And that's where decisions of interest rates are made.

The very rates that ripple out to what we all pay for our homes, our cars, and credit to name a few.

But here's what makes the Fed different.

It's often described as independent within government.

Yes, Congress created it.

And yes, its governors are presidential appointees.

But once in office, policymakers don't take direct orders from the White House, Capitol Hill, or anyone.

Still, the Fed Chair testifies regularly to Congress.

Its books are audited and the public gets frequent reports.

Yet, like many presidents before him, President Trump is pressuring the Fed.

He's calling for a faster and deeper interest rate cuts.

And for those decisions to be made in advance of data reports.

And he got a little what he wanted last week because the Fed announced it would cut rates a quarter point.

Though Chair Jerome Powell maintained a decision was not influenced by the president.

There's a constant tension baked into the system on purpose.

The Federal Reserve is designed to be independent from the president.

Yet the central bank makes economic decisions that affect every borrower, every saver and every voter.

So can its independence be protected?

Let's find out in the center ring.

♪ ♪ KATKO: Joining me in the Center Ring is senior fellow at the Brookings Institute and former vice chair of the Federal Reserve, Donald Kohn.

Welcome, Mr.

Kohn.

KOHN: Good to be with you, John.

KATKO: So let's start from the beginning: What is the Fed?

KOHN: The Fed is the nation's central bank.

It's the bank that was put in place in order to help the U.S.

economy grow and prosper.

Put in place in order to prevent financial crises and deal with them when they happened.

You could think of it as a banker's bank.

It's a bank that banks can come to borrow money when they absolutely need to.

It's the central monetary policy authority in the United States tasked by Congress with stable prices and maximum employment.

KATKO: So the Fed itself, as we call it, how does that affect the American economy?

And Americans as a whole?

KOHN: So the prime, a couple of ways that, it affects the American economy and Americans as a whole.

The primary way is through monetary policy.

What's monetary policy?

That's mostly raising and lowering interest rates in order to keep the economy on a steady course, in order to keep unemployment low and inflation low price stability.

So, for example, when, as last week, the Federal Reserve was a little bit concerned about the, labor markets weakening, the unemployment rate had risen a little bit, people were having more trouble getting jobs.

So they said, let's stimulate the economy.

How did they go about doing that?

They went by lowering interest rates.

They lowered the interest rate they target for money markets, for very short term markets, called the Federal Funds Rate.

They lowered it by a quarter of a point.

Not a big deal, but it is lower.

What they do then radiates through the financial markets.

So the price that you and I might, the rate that you and I might pay when we borrow to buy a car or to buy a house or a car or to buy a house or a mortgage is four years, might be 30 years for a mortgage.

The rate a business might pay when it thinks about putting up a new factory and borrowing to put up a new factory, maybe a 4 or 5-year rate.

So the Fed doesn't control those rates directly, but when it raises and lowers that short-term rate, it tends to radiate through the economy.

So the hope was last week we've lowered rates by a little bit, households and businesses will be encouraged to spend because the rates they will be borrowing at will also should also be a little lower over time.

So that in term, if people are encouraged to borrow and spend, that means they'll the businesses will have demand, they'll be hiring people.

And this weakness in the labor market that Jay Powell talked about should be very, very limited if businesses and households are doing more spending.

KATKO: So you're talking about weakness in the labor market and you lower rates generally to stimulate the economy.

The big bugaboo seems to be that inflation is going ticking up a little bit.

And so that's something that the Fed has to balance out and make game-time decisions, taking into account everything?

KOHN: Absolutely, that's a very good point John.

So we're in a at a actually in a fairly unusual situation in which inflation they want low inflation, they want prices to be stable.

Congress has told them that's your job, one of your jobs to keep prices stable.

They told them the other job was to keep employment high, to keep people working, making sure that people who wanted jobs could find jobs.

Usually those things go together.

Inflation is generally low of people.

If the jobs are abundant, inflation can tend to tick up.

We are in an unusual situation right now in which those two goals are in tension.

Inflation is ticking up while job finding is going down.

And what the Federal Reserve said last week when it lowered rates and Jay Powell explained in his press conference is we're a little more worried about the jobs situation than we were just a couple of months ago.

The inflation situation is, unusual and it's somewhat worrisome, but hasn't gotten worse.

Part of the inflation picture now is the tariffs that the Trump administration has put on.

So tariffs are a tax on U.S.

consumers, U.S.

businesses that buy imports from other countries, buy goods from other countries and then resell them to U.S.

households and businesses.

So that tax has gone up.

The Trump administration has increased that tax.

Businesses, of course, to some extent absorbed that and increased costs, but they also tried to pass it on to consumers.

Although the pass through to consumers has been a little less than economists expected at the beginning of this tariff round, it still has happened.

So we find prices of goods that are subject to tariffs are going up, and a bit more slowly, but they're going up.

So some of the inflation is temporary because it's just passing through these tariffs, and it won't be continued, but it's not clear that all of that is.

So yes you're right, the Fed finds itself in a very tricky position right now.

KATKO: Now let's switch gears a little bit.

And I want to talk about the influence of government and government leaders attempt to have on the Fed and President Trump is nothing new to this.

Many other presidents have attempted to do the same thing.

So what keeps the Fed from being overly influenced by leaders or members of Congress?

KOHN: Well, you're certainly correct that President Trump is not the first president who wants interest rates to be lower, who objects to interest rates going higher.

As I think back through the Fed history, just after World War II, Harry Truman didn't want rates to go up.

Lyndon Johnson very famously tried to do fight the Vietnam War and didn't want the Fed fighting the resulting inflation by raising rates.

And he'd berated the chairman of the Fed at the time.

Richard Nixon put a lot of pressure on Arthur Burns not to raise rates, particularly before the 1972 election.

Ronald Reagan ordered Paul Volcker not to raise rates before the 84 election.

So this is not -- and of course Donald Trump.

So it's very common for presidents to want rates to be lower.

Why?

Because lower rates, as I just said, lower rates tend to stimulate the economy.

They tend to stimulate spending, stimulate employment.

And of course, that's good for reelection.

And often the inflation result of stimulating the economy too much, pushing demand against available supply is delayed beyond the next election.

So presidents often want interest rates to come down, especially when they're looking at elections or in case of Donald Trump amid a midterm election, that he wants his party to be successful.

KATKO: Mr.

Cohn, let me interrupt just briefly.

We have about a minute left.

I just want to finish with this note, and that is if you could just summarize for us why it's so important for the Fed to remain independent.

KOHN: So it's important for the Fed to take that longer term perspective.

To see that, if you push the economy really hard in one direction, eventually if you stimulate the economy, eventually you're going to have inflation, and everyone will suffer from that inflation.

So you need someone sitting there with an arm's length relationship to this political process in order to take that longer perspective for the benefit of the American people, to keep inflation down over time, to be to have that good perspective.

KATKO: Thank you very much for your time, Mr.

Kohn, and your time on the Fed as well.

Now, let's hit the trapeze.

♪ ♪ KATKO: Taking to the trapeze this week to discuss how to keep the Fed from political influence are Democratic Congressman, Juan Vargas of California and former Republican chairman of the House Financial Services Committee, Patrick McHenry.

Thank you both for being here, gentlemen, and we want to get right into it with you.

Why is it important for the Federal Reserve to be independent?

VARGAS: Well, I think it's important for the Federal Reserve to be independent, because we want a central bank in a modern economy like ours, a modern industrialized economy, to have people making decisions long term for the economy, for the issue of stable prices and also for the issue of employment.

You don't want people making quick political decisions, politicians like myself.

Instead, you want people that are there for a long period of time that are secure in their position and saying, okay, what is good for this economy long term, not what is good for the politicians in a way that helps them for the next election, because that could be disastrous for your economy.

And that's why I think it's very important to have something like the Fed in a country like ours, where they're somewhat independent of politics and making decisions, monetary decisions that keep the economy going in a way that's efficient and a way that allows them to grow without undue influence by politicians.

KATKO: Patrick, is the Fed independent in your mind?

McHENRY: The Fed is independent.

And as Juan outlined, and he and I agree that the Fed should, should be independent.

But as Juan outlined, you have a process under the law that created the Federal Reserve, by which the president has appointees and the Senate confirms those appointees.

So that is a political check on the Federal Reserve.

The structure of the Federal Reserve is to be representative.

So we have regional banks that are supposed to bring the facts on the ground from that region to monetary policy decisions by the Federal Reserve.

Number one.

Number two, there are long terms.

The longest terms in our government are Fed governors.

And so the idea here is to appoint somebody, free them from the day-to-day politics that the rest of the government lives under, and say your mandate is to have a view of stable prices for the long term.

I think that is necessary and good for us to have a prosperous country where we have proper allocation of capital and get the greatest outcome for our people.

Now, every president has an opinion about Federal Reserve decisions.

Lyndon Johnson at one point had a physical confrontation with one of his Fed chairs.

You know, you go back to FDR, during the Great Depression.

He determined the price of gold, which then determined the decisions the Federal Reserve was required to make under the act at that time.

So from time to time, presidents have had a big say in the decisions and have been vocal about it.

So what President Trump is doing is in that longer term view.

What most presidents have at least privately thought, and in some cases have publicly stated.

KATKO: Juan, has Donald Trump gone too far as far as attacking the independence of the Federal Reserve?

VARGAS: Oh, he's gone way too far, of course he has.

I mean, it is fascinating to me because obviously he's going after the chairman and one member, but the chairman is the person he picked.

You know, everybody thinks Powell is a Democrat now.

Trump picked him, and I think he's done a pretty solid job.

We have to remember, we went through a pandemic.

Something that's historic in nature, and I think he did a pretty good job.

Now that some people say he was too slow to move it could be.

But at the same time, you remember we didn't go into a depression.

We could have very easily slipped into something terrible if there wasn't prudence at the Fed.

So what has happened now is the president doesn't like the politics.

Everything's got to cut much more quickly.

So he's saying all these things, not true or unsubstantiated.

This kind of pressure is not good.

Chairman McHenry made a good example, gave a couple good examples, but he didn't give the most recent one which, of course, was Nixon in the 70s.

Nixon in the 70s, too, pressured the Fed and the Chair and they made a decision, I think, based on politics, and it created stagflation.

You know, it was it was horrible for the economy, and I think that's why we should keep the president the heck out of the politics here.

KATKO: Juan, isn't President Trump just trying to hold the Fed's feet to the fire?

Just keep him accountable criticism by criticizing him and attacking them.

>> VARGAS: I think that's fine to criticize, but the attack, the issue of saying, okay, this governor right here, and we're going to remove her for cause when it's completely unsubstantiated, or attacking the Fed Chair and saying there's cost overruns in this building, therefore that's cause and he ought to be fired.

You know, that's baloney.

What that does, is it causes a lot of uncertainty in our economy and certainly internationally because they don't know what the heck's going on.

That's what he should stay out of.

He can say, hey, I think the rates are too high, I think this guy acts too slowly, you know, he misses the signs.

Okay, that's fine.

But trying to put his own people in there kind of stuff in the corners, if you will, that's wrong.

That's not a good thing to do.

KATKO: So, Patrick, it seems that there's this reverence for the independence of the Fed, for the reasons you both articulated.

But there's also a concern about accountability from things like, properly and analyzing data in a proper manner in a quick manner and other things.

There is some question about reform.

So I'd like to hear would you have suggested reforms to the Fed?

And as part of those reforms, would you ever think about removing presidential appointments and take away some of that sting of the president's influence?

McHENRY: No.

The checks and balances in our constitutional republic require the presidential appointment and Senate confirmation of really important folks in our government.

I think the Fed should be included in that nature.

I would say that from time to time, we address the statute the Federal Reserve acts under.

That's been done multiple times, actually, dozens of times, over the last 100 years.

So it is not outside the bounds to address the statute and make sure it is a more resilient, more representative, more accountable agency or central bank.

And so I think it is important for Congress to look at this.

We've given the Fed regulatory powers that they have misused or failed to use appropriately.

We've checked that, we've changed that, and we've repeatedly changed that over the over the last 30 years in particular.

So for us to address the statute is good.

And that is a proper thing the government should undertake.

I think you can change the Open Markets Committee and make it more representative of where the economy is.

I think you can make sure that the data they use and the systems to collect that data are the best they can possibly be, which means you need to make sure they're well funded and good appointees running those agencies.

I think there's some really important things to make sure we deliver here, even amid this highly divisive politics around the Federal Reserve.

KATKO: So we've got about a minute left, so I'll ask each the same question, and I'll start with Patrick.

Should the president have the ability to remove members of the Fed?

McHENRY: Yes, and he does under the statute, And the courts are testing this for the first time on whether or not this was an appropriate firing that President Trump made of Governor Lisa Cook.

We will find out if the Supreme Court will opine on that one.

VARGAS: I think the president should be able to fire people, but for cause, not for baloney.

And I think that's what he's attempting to do right now.

And I think that the courts have already said it, and I think the Supreme Court will get the last say, but it really has to be for cause, not for this stuff that's made up because he wants that lower interest rate.

KATKO: Gentlemen, I appreciate you both so much for your input.

Thank you very much.

And now it's time for my take.

♪ ♪ KATKO: I believe it's critical for the Fed to maintain its independence.

For more than a century, that independence has helped guide the U.S.

economy through many turbulent times.

Independence ensures consistency and trust.

Critical factors for the U.S.

'dollars global status.

And while it's tempting for the party in power to tamper with the Fed for its own purposes, what happens when the opposing party has its opportunity.

We've risked with flip flopping policies that could spook the market and erode public confidence.

Consistency and long-term stability are the bedrock of sound economic policy.

Overall, the system works.

And as the saying goes, If it ain't broke, don't fix it.

With that being said, Congress has the ability to adjust the Fed's priorities, and they have done so many times in the past.

The Fed needs to continue to keep up with the times and respond accordingly.

Data is at the fingertips of the Fed much more quickly than in times past.

The Fed simply can't sit on its hands and rely on outdated data analytics.

Moving quickly on the latest data allows the Fed to be more limber and timely in reacting to present day financial issues.

And that's just one example of where Congress can make the Fed more efficient.

And that's my take.

♪ ♪ KATKO: Joining us now from our nation's capital is Bloomberg's Laura Davidson to fill us in on what's happening next week in Washington.

DAVIDSON: So this week is all going to be about whether or not the U.S.

government is going to shut down.

This deadline hits Tuesday at midnight, and it really remains to be seen where that where the two parties are going to be.

They've been out of Washington all last week.

The Senate will come back on Monday.

The House isn't even scheduled to come back until Wednesday.

The big fault line here is this is essentially Democrats one point of leverage.

They are out of power both in the House, Senate and White House.

So they're using this shut down.

And basically they need to get 60 votes in the Senate, which means that at least a handful of Senate Democrats need to join with Republicans to pass something.

So they are asking for a couple different things.

One, they want an expansion of some of these ACA Affordable Care Act premium tax credits that are set to expire.

They want to extend those.

They're saying a lot of people are going to face extreme health care cost increases without that.

They're also asking for more power of the purse.

This has traditionally been Congress's job.

They've been responsible for appropriating money.

But as we've seen over the past several months here, as the Trump Administration has really put a bigger clamp down on funding and canceling funding that was approved by Congress.

We saw this with a big rescissions package that was passed earlier this year, cutting funding for the Corporation for Public Broadcasting, PBS, NPR, as well as a bunch of other foreign aid packages as well.

So Democrats see this as a one opportunity when there was a, you know, we were on the brink of a shutdown earlier this year.

Democrats ended up working with Republicans to cut a deal.

And Senate leader Chuck Schumer ended up facing a lot of blowback from the Democratic base who wanted to see him put up more of a fight.

And this is where we find ourselves now.

KATKO: I'm hearing some chatter that the Affordable Care Act component of their concerns might have a little bit of legs with respect to moderate Republicans in the House.

Is that true?

DAVIDSON: Yes.

You see a handful of moderate Republicans who have been expressing worry that this is going to hurt their own constituents.

This is really part of a broader narrative we've heard around health care this summer, especially in the light of Trump's one big, beautiful bill passing earlier this year that includes some cuts to Medicaid in the coming years.

So this has become an issue that politically, Republicans, particularly moderate Republicans, but those also representing more conservative districts in rural areas where federal health care funding is more widely used by the population, and that this is going to be an issue that are really going to hurt them come the midterms, which are just about a year away.

KATKO: Does it seem to some extent that maybe the Democrats are actually looking for a fight and they use that the broader term of the powers of the purse concerns to really kind of use that as leverage to have the government shut down so then they can blame Republicans?

DAVIDSON: Yes, the tone among Democrats is very different from how it's been in prior shutdowns where they kept calling for, looking for a resolution that they wanted to work together and wanted to avoid a shutdown at all costs.

The level of vitriol has really ratcheted up here.

And you see both Democrats see this as a possibility to take a political stand and make a political point and potentially win the political argument here.

Republicans, however, also see this, and they've been branding it as a Schumer shutdown.

So right now what you have is both sides messaging to see who can be -- own the political win of the shutdown and avoid being cast the blame.

KATKO: Laura Davidson, thanks so much.

I'm glad I'm not in Congress anymore.

That's all for this week, folks.

To send in your comments for the show or see "Balancing Act " extras and exclusives follow us on social media or go to BalancingActwithJohnKatko.com.

Thank you again for joining us.

And remember in the circus that is politics, there is always a "Balancing Act."

I'm John Katko.

We'll see you next time, America.

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