Fed Pressure

Don't End Independence

Die nach Westen gerichtete Fassade der Zentrale der Europäischen Zentralbank (EZB) reflektiert am 30.08.2016 in Frankfurt am Main (Hessen) das letzte Tageslicht, während die Straßen und Brücken am Fluss bereits von Lampen erhellt werden. Foto: Frank Rumpenhorst/dpa +++(c) dpa - Bildfunk+++
The European Central Bank (pictured) as well as the Federal Reserve need to see to it that their independence is protected.
  • Why it matters

    Why it matters

    The author questions the gradual decline in the independence of central banks and warns against attempts by politicians to intervene in monetary policy.

  • Facts

    Facts

    • The Federal Reserve last raised interest rates in December 2015, marking the first increase since 2006. Another interest-rate hike in December is now becoming likely.
    • The separation of monetary policy from government interference has contributed to curbing inflation and created great confidence in monetary policy over the past few decades.
    • Rising inflation remains a relatively low risk in the United States and the European Union.
  • Audio

    Audio

  • Pdf

The Federal Reserve will be under the spotlight once again as it makes its next decision on rates on Wednesday. In all likelihood, it will be a non-decision, with the U.S. central bank’s benchmark interest rate remaining at between 0.25 and 0.5 percent.

Fed Chair Janet Yellen will likely highlight that the U.S economic outlook has improved, though not so clearly as to make a new rate hike in December a foregone conclusion. Instead, she will choose her words carefully, making a December increase a realistic option.

Experts also expect the members of the monetary policy committee to slightly lower their forecasts. In other words, they now expect somewhat slower growth for the coming years, combined with restrained forecasts on inflation and a very flat path toward additional rate hikes.

Central banks cannot be allowed to become a fourth power within the state, one that becomes a receptacle for everything we don't wish to openly ask of voters.

During the summer months, monetary policy experts have increasingly internalized the view that the U.S. economy will have to live with relatively low interest rates over the long term. In other words, no sudden moves are expected.

But there’s another issue that will probably become more explosive and dangerous both before and – maybe even to a greater extent – after the U.S presidential election: the Fed’s independence.

Paul Singer, a well-known conservative hedge fund manager, recently characterized the independence of central banks as “overrated.”

Conservative politicians in the United States already want to gain control over the Fed. Republican presidential candidate Donald Trump accuses it of being extremely politicized. He said recently that Ms. Yellin should be “ashamed” for consciously supporting the administration of President Barack Obama.

This is nonsense, and suggests an ulterior motive. Those accusing the Fed of being in the lap of the government are actually creating a pretense for their own meddling in its business. And aside from the misplaced ambition of some politicians, there are economic trends that are also calling the independence of central banks into question these days.

Disconnecting monetary policy from government interference was a great achievement of the last few decades. It contributed to curbing inflation and has created so much confidence in monetary policy that excessive inflation hasn’t been an issue in most developed countries for a long time.

But this long-forgotten success is precisely why the independence of central banks seems less important or “overrated” today.

Furthermore, in recent months almost all economists have been united in calling for fiscal policy to replace monetary policy as a driver of growth. The monetary watchdogs themselves, from Ms. Yellen to European Central Bank President Mario Draghi, agree.

But fiscal policy as a driver of growth means governments taking on more debt. It requires an even stronger, unspoken guarantee by central banks to stand behind that debt, if necessary. This is concealed behind the idea that fiscal and monetary policy should cooperate more closely.

In Anglo-Saxon countries, the “independence” of central banks has never meant that fiscal and monetary policy experts never communicate. This is why many British and American economists were skeptical of the ECB from the beginning, since the large number of participating nations makes it nearly impossible for the two branches of economic policymaking to cooperate effectively.

But even in the euro zone, the ECB has come under the de facto control of countries in the past few years. National governments have essentially left it up to the ECB to avert a breakup of the euro zone. This has forced the ECB to interpret its mandate very broadly, so that it increasingly runs the risk of engaging in a sort of hidden E.U. fiscal policy, albeit with inadequate means.

It becomes the height of hypocrisy when individual governments, such as the one in Berlin, turn these actions into an indictment of the ECB.

Actively exerting influence isn’t the only way a government can undermine a central bank’s independence. Another way is to passively neglect resolving problems so that they end up in the central bank’s lap. This is the dangerous link between current economic trends and the attempt by politicians to directly or indirectly influence monetary policy.

Perhaps this is not especially damaging in the short term. Both the United States and Europe are a long way from having too much inflation. Money isn’t evaporating into thin air, nor is the system exploding, and the prophets of doom have been consistently wrong until now.

But the long-term consequences are more dangerous. Monetary policy is complicated enough, and it doesn’t get any better when politicians intervene. The blurring of responsibility between central banks and governments ultimately leads to an irresponsible regime and undermines democracy.

Central banks cannot be allowed to become a fourth power within the state, one that becomes a receptacle for everything we don’t wish to openly ask of voters.

 

To contact the author: wiebe@handelsblatt.com

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