Trump wants interest rates to drop to 1%, Warsh rejects it with "five years of inflation exceeding the target": A battle for central bank independence between 3.75% and 1%.

The contest between the Federal Reserve and Trump is entering its most direct confrontation phase.

The Federal Reserve raised interest rates for the first time in three years, increasing the federal funds rate by 25 basis points to a range of 3.75% to 4%. Trump immediately publicly demanded that rates be pushed down to 1% or even lower, accusing the Fed of "politically motivated" actions against him. Fed Chairman Warsh responded clearly at a press conference: inflation has exceeded the target for more than five consecutive years, and this rate hike decision is in line with the Fed's dual mandate and was unanimously approved by the committee.

The essence of this standoff is a structural tension between an economy with relatively strong fundamentals and a government that continues to be aggressive on fiscal, tariff, and geopolitical policies. The Federal Reserve has chosen to stand firm, while Trump's proposed 1% interest rate is neither justified nor feasible in the current macroeconomic environment.

The first interest rate hike in three years, cited by Warsh as evidence of "excessive inflation".

The Federal Reserve announced a 25-basis-point interest rate hike last week, the first increase in three years. In the subsequent press conference, Warsh presented two key arguments: first, inflation has been above target for more than five consecutive years, making price stability a current policy priority; second, the US economy is currently showing signs of strengthening, making a moderate removal of the accommodative stance necessary in this context.

This decision represents not only a shift in policy direction but also a direct response to market signals. On September 17, the yield on 10-year Treasury Inflation-Protected Securities (TIPS) was approximately 2.6%, while the yield on traditional 10-year Treasury bonds was approximately 4.9%, implying an inflation compensation of approximately 2.3%. Historically, both nominal and real yields have largely returned to levels seen before the 2007-2009 financial crisis. Considering recent economic performance, current yield levels are within a reasonable range.

More notably, Warsh refused to support or endorse Trump's calls for significant interest rate cuts at any level—neither in policy stance nor in rhetoric. The decision to raise rates was ultimately passed unanimously by the committee, demonstrating a high degree of unity within the institution.

Trump's 1% claim: Logically untenable

Trump stated on social media that the United States is "the most creditworthy country in the world" and that interest rates "should be 1% or even lower," accusing the Federal Reserve of raising interest rates as a "political act against Trump." He also revealed that he had told Warsh, "Just follow the committee's vote, because the result won't make any difference."

However, the logic behind short-term policy interest rates is not directly related to a country's credit rating. Short-term interest rates are driven by macroeconomic variables such as inflation and unemployment, rather than a country's credit rating. Long-term nominal interest rates, on the other hand, are determined by real interest rates, expected inflation, and various risk premiums. Given the current context of inflation remaining above target and persistently high fiscal deficits, lowering the policy rate to 1% implies a real interest rate of approximately -2%, a level that could very likely trigger protests from creditors and even loan strikes.

Furthermore, the statement that "the United States has the best credit in the world" is itself worthy of examination. The word "credit" comes from the Latin word "credere," meaning "to believe." The United States boasts the world's largest and most dynamic economy, but the credibility of its government is under pressure due to the Trump administration's continued rule-breaking fiscal and tariff policies. Analysts point out that given the massive fiscal deficit, heavy reliance on external financing, and the trend of bond holdings shifting from long-term holders to hedge funds, a financing crisis is not inconceivable.

Excessive inflation over time and the policy multiplier: Multiple pressures combined

From a broader perspective, since 2021, both overall inflation and core inflation indicators have consistently remained above their targets. Meanwhile, the demand expansion driven by the AI investment boom, the Trump administration's loose fiscal policy, the supply-side shock from tariffs, and the energy price shock caused by the Iraq War—these multiple factors combined have made the prospect of a natural decline in inflation more uncertain, with the pressure actually pointing upwards.

Against this backdrop, some observers have raised substantial questions about Warsh's monetary policy framework. Renowned economist Claudia Sahm, in her Substack column, raised several key questions: Through what mechanisms does monetary policy actually promote growth? If a tight monetary policy doesn't suppress economic activity, what other paths can it take to lower inflation? Does Warsh have a clear understanding of the "neutral interest rate"? If not, how does he assess the current level of policy easing? These unresolved questions are important dimensions for observing the Warsh Fed.

However, Warsh's cautious approach to economic predictability, while partly a methodological divergence from some of his critics' concerns, is not entirely contrary to them.

Central bank independence stress test: The final test is yet to come.

The current standoff reflects a deeper structural issue: how can an economy with relatively sound fundamentals cope with a government that consistently oversteps its fiscal and policy boundaries? The Federal Reserve's responsibility is to maintain the credibility of its inflation target, free from political pressure; the pressure from the Trump administration is placing this responsibility under public scrutiny.

Warsh's current stance is to maintain a conventional monetary policy framework and not concede to political pressure. The unanimously agreed rate hike decision is significant at the institutional level. However, as analysts have pointed out, the real test of this game may yet be yet to come—whether the Federal Reserve can maintain its stance amidst rising fiscal and inflationary pressures will be the core variable determining the ultimate outcome of this contest.

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