When inflation surged in 2021, the Federal Reserve may have been slow to act on interest rate increases, but inflation expectations data from that period showed markets generally believed prices would eventually cool down. This fact made the Fed's anti-inflation battle easier to advance and less costly—even before the US central bank raised rates, bond markets had already proactively tightened financial conditions.

On Saturday, at a Federal Reserve conference held in Wyoming, University of California Berkeley economics professor Emi Nakamura presented a paper to global central bank officials. In her paper, she pointed out that the 2021 experience both demonstrated the actual value of the Fed's credibility and revealed the risks that could arise if this trust were damaged—and now, this risk is no longer abstract: US President Donald Trump took action on Monday attempting to fire Fed Governor Lisa Cook, marking the first time any US president has made such a move.

"People easily forget what a remarkable achievement it was for the Fed to maintain almost completely stable long-term inflation expectations while facing 7% to 8% high inflation. Achieving this requires extremely strong reputation support," Nakamura stated, noting that such reputation "depends on institutional safeguards like central bank independence and good historical records, which take a long time to build but can collapse in a short period."

So far, market reaction to the "firing of Cook" news has been relatively mild, but analysts believe that even though it's still uncertain how quickly this loss of trust will affect policy decisions or market pricing, "the seeds of distrust have been planted." For example, Trump may not successfully remove Cook, which could actually enhance the Fed's standing. The Senate's attitude is also crucial—Fed officials' appointments require Senate approval, and bipartisan senators typically express clear support for central bank independence.

Currently, markets expect Fed policymakers to begin cutting rates at their September 16-17 meeting, while Cook has stated she will continue participating in policy discussions.

Even so, Maurice Obstfeld, professor emeritus of economics at UC Berkeley and former chief economist of the International Monetary Fund, points out: "This is a major shock to the Fed's effectiveness as an independent institution, and independence is the foundation of the Fed's price stability mission."

"This will make it harder for the central bank to fulfill its other core responsibility—supporting employment in the economy—without undermining inflation expectations stability," he said. "Markets will realize that monetary policy decisions may be more politically motivated, and the central bank will be widely viewed as more focused on the government's other objectives, such as financing massive fiscal deficits."

Trump has consistently demanded interest rate cuts, believing this could reduce the government's cost of financing massive deficits. But in reality, if markets lose confidence in the Fed's inflation control capabilities and demand higher inflation premiums in US Treasury auctions, this idea could backfire.

**"He Has No Authority to Do This"**

Since Congress passed a series of reforms in the 1930s establishing the Fed's current structure (historians say these reforms were explicitly designed to remove monetary policy from White House control), the Fed's reputation and independence have never been fully tested under "pressure from a strong president."

Core features of this structure include: Federal Reserve Board members in Washington serving 14-year terms; power division between the Board and 12 regional Federal Reserve Bank presidents (reflecting the federal structure of US government). The core logic is that elected officials are often unwilling to make difficult and unpopular decisions to control inflation, while independent experts are more inclined to prioritize data and analysis over electoral outcomes.

But this structure also frustrates Trump and his administration's agenda to "expand executive power." Since returning to the White House in January, Trump has tried unsuccessfully to pressure the Fed to cut rates, so on Monday he cited controversy over two housing mortgage loans Cook applied for before joining the Fed as providing him with "grounds" to fire Cook.

Cook is the first Black woman to serve as a Fed governor, and her supporters note that her term extends to 2038, far beyond Trump's presidential term; the other two Fed governors appointed by former President Joe Biden also have terms longer than Trump's. Although Trump can appoint a new chair after Jerome Powell's chairmanship expires next May, currently it appears that Trump-appointed governors won't likely constitute a majority on the Fed Board until 2028 (the last full year of his presidential term)—creating a major obstacle to his reshaping of the Fed.

Even then, there's no guarantee that Fed governors confirmed by the Senate would comply with any White House demands, and regional Federal Reserve Bank presidents, who are independently hired, also participate in policy decisions.

Cook's mortgage issue has been referred to the US Department of Justice, but no formal action has been taken yet. On Monday evening, Cook responded to Trump in an email statement: "From a legal standpoint, there are no legitimate grounds for firing me, and he has no authority to do so." Cook's lawyer, prominent Washington attorney Abbe Lowell, stated: "We will take all necessary actions to prevent him from implementing this illegal act."

The unfolding developments may become an important test of two key questions: First, does the Fed's independence in monetary policy stem from practical convention or actual legal protection? Second, how important is this independence for US and global financial markets that view the Fed as a "stabilizing force" and "core pillar of the global financial system"?

For example, during crises, the Fed has rapidly taken cross-border actions to stabilize markets without political constraints—through tools like "currency swap lines," ensuring other central banks can obtain the dollar liquidity they and their domestic companies might need.

The Federal Reserve Act does allow removal of Fed governors for "just cause," but it doesn't clearly define what constitutes "just cause." The US Supreme Court recently seemed to establish an exemption for the Fed in a similar dispute, stating that governors cannot be removed solely due to disagreements over interest rate policy.

But Columbia Law School professor Kathleen Judge points out that these have not yet become final rulings, and many questions about the Fed's status remain unclear.

"The legal framework in this area is incomplete because we have never relied solely on formal law to protect Fed independence in the past. Although multiple presidents have pressured Fed chairs, we have never faced a situation where a president attempted to fire a Fed governor," Judge said. "If a president is determined to pressure the Fed to comply with their monetary policy preferences based on a broad interpretation of their inherent powers under Article II of the Constitution, the Fed's independence may be difficult to maintain."