Fed independence faces its biggest test in 75 years

Kim Sung-jae

The author is a business administration professor at Furman University and the author of “The Story of Tariffs” (2025). 

In the first half of 1950, the U.S. economy appeared to have finally shaken off the aftermath of World War II. Growth reached 14 percent while prices actually fell. Then the 1950-53 Korean War broke out in June, abruptly ending the calm.

Fearing a third world war and possible rationing of sugar, nylon, canned food and beef, U.S. households began hoarding necessities. Companies rushed to secure industrial raw materials.

The U.S. defense budget, which stood at $13 billion before the war, surged 73 percent. As aggregate demand soared, inflation quickly climbed above 8 percent, alarming the U.S. Federal Reserve, which was responsible for maintaining price stability.

Yet the Fed’s hands were tied by the wartime policy of pegging Treasury yields. Short-term government bond yields were capped at 0.375 percent and long-term yields at 2.5 percent.

Whenever weaker demand for Treasurys pushed yields upward, the Fed had to create money and buy bonds without limit. It also absorbed Treasury debt the market would not take. Frustration mounted as inflation surged while the central bank remained unable to control interest rates.

After the Fed publicly criticized the peg, President Harry Truman summoned its entire policymaking board to the White House in late January 1951, an extraordinary attempt to quell its resistance.

Public opinion had already shifted. Artificially low rates were increasingly seen as benefiting banks at ordinary Americans’ expense. Under intense pressure from the U.S. Congress and the public, Fed Chair Thomas McCabe eventually resigned from his post.

In March, the Fed and Treasury agreed to separate monetary and fiscal policy. The Fed regained independence to fight inflation through interest rates, while new Chair William McChesney Martin used pre-emptive rate increases to curb inflation before price pressures could become entrenched.

That 75-year-old principle — the Treasury does not interfere in monetary policy and the Fed does not finance government debt — is again coming under strain today, in a striking echo of that earlier era.

Kevin Warsh, who took office as Fed chair in May, has argued that the Treasury should be consulted when determining the size of the Fed’s balance sheet.

The Treasury, meanwhile, has intervened in currency markets alongside Japan and bought government bonds directly to stabilize long-term yields, moving into territory once occupied by the central bank. Yet stubborn market rates are themselves demonstrating why Fed independence matters.

Whatever the debate over Fed independence or whether history is repeating itself, one lesson is clear: When interest rates are left to politics, markets pay the price.