President Trump has a new nickname for Jerome Powell: \u201cMr Too Late.\u201d The American president accuses the Federal Reserve chair of being \u201cbehind the curve\u201d in cutting interest rates, just as he and his colleagues were too slow to tighten during inflation\u2019s resurgence. Last week, Trump toured the Fed\u2019s building renovations, complaining loudly about cost overruns. The unsubtle message: We don\u2019t like Powell\u2019s monetary policy, so we\u2019re hunting for other reasons to sack him. <\/p>\n
This political pressure to lower interest rates alarms former Fed chairs Ben Bernanke and Janet Yellen. Writing in the New York Times, they state that \u201ckeeping politics out of monetary policy decisions leads to better economic outcomes\u201d. They\u2019re right that politicising monetary policy could be very destructive. But doesn\u2019t their argument miss the wood for the trees? Long-term, the graver danger to central bank autonomy isn\u2019t Trump\u2019s tweeting, it\u2019s US politicians\u2019 borrowing.<\/p>\n
Unless something drastically changes, unsustainable government debt trajectories risk unleashing \u201cfiscal dominance\u201d, whereby monetary policy becomes subservient to government funding needs. The current debt outlook for countries like the US and UK could usher in a world in which fiscal realities constrain monetary decisions, weakening central banks\u2019 grip on inflation.<\/p>\n
\u2022 IMF warns on attempts to undermine independence of central banks<\/a><\/p>\n As David Beckworth, economist at George Mason University, puts it: \u201cThe consolidated government budget constraint must hold.\u201d All government spending must ultimately be financed by tax revenue, debt issuance or money creation. If politicians keep running very large deficits, as the US seems intent on, and debt tests market limits, higher inflation is all that\u2019s left to pick up the slack.<\/p>\n Unsustainable government debt eventually traps a central bank. Markets start demanding higher yields to compensate for default risk or higher inflation expectations, leaving central banks an unenviable choice. They can tighten policy to curb inflation expectations, driving up borrowing costs and risking acute fiscal crisis. Or they can abandon their inflation target, aiding the government as higher inflation erodes the real value of government debt.<\/p>\n To avoid spiralling interest rates in the latter scenario, governments have historically imposed financial repression too, mandating institutions to buy government bonds or capping interest rates to ensure negative real rates. In short, under fiscal dominance, monetary and financial policies get subordinated to support government\u2019s financing needs, with more tolerance for high inflation.<\/p>\n Trump\u2019s specific attacks on Powell illustrate this danger. The president isn\u2019t simply complaining that Fed policy hurts the real economy. He\u2019s moaning that tighter money is making government borrowing pricier. The worse the debt outlook, the greater the risk the Fed loses its ability \u2014 what Beckworth calls its \u201ceconomic independence\u201d \u2014 to control inflation.<\/p>\n \u2022 Markets are the casualty of Donald Trump\u2019s war on Federal Reserve<\/a><\/p>\n Economists like me have long argued that inflation depends entirely on monetary policy, not deficits. Larger deficits don\u2019t automatically produce higher inflation unless central banks accommodate them, we said. That\u2019s true: under normal conditions, inflation wholly hinges on central banks\u2019 monetary actions and credibility.<\/p>\n But fiscal dominance is far from normal. When unsustainable debt erodes the boundary between monetary and fiscal policy, inflation slips out of central banks\u2019 control. During the pandemic, we got a preview of how effectively monetising government borrowing could fuel inflation. Unless America cuts future budget deficits, that episode will repeat.<\/p>\n \u2022 Trump hails \u2018good meeting\u2019 with Jerome Powell over interest rates<\/a><\/p>\n How did we get here? Ironically, central banks\u2019 political independence may have encouraged fiscal recklessness. With inflation control outsourced to central banks, politicians perhaps borrow more aggressively, especially during downturns when quantitative easing distorts bond market signals.<\/p>\n Bernanke and Yellen are right that Trump\u2019s pressure is dangerous. Politicians can criticise monetary authorities if they think policy misfires on inflation or growth, but pressuring Powell to reduce government borrowing costs \u2014 as Trump <\/a>does \u2014 crosses a dangerous line.<\/p>\n Yet Trump\u2019s rhetoric wasn\u2019t born of a vacuum. He\u2019s worried about government debt interest costs because the debt is high. Ultimately, reckless government borrowing, not Trump\u2019s commentary, poses the real threat to meaningful Fed independence.<\/p>\n Ryan Bourne is an economist at the Cato Institute and editor of the book The War on Prices<\/p>\n","protected":false},"excerpt":{"rendered":"President Trump has a new nickname for Jerome Powell: \u201cMr Too Late.\u201d The American president accuses the Federal…\n","protected":false},"author":2,"featured_media":34889,"comment_status":"","ping_status":"","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[11],"tags":[84,1294,56,54,55],"class_list":["post-34888","post","type-post","status-publish","format-standard","has-post-thumbnail","category-economy","tag-business","tag-economy","tag-uk","tag-united-kingdom","tag-unitedkingdom"],"_links":{"self":[{"href":"https:\/\/www.newsbeep.com\/uk\/wp-json\/wp\/v2\/posts\/34888","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.newsbeep.com\/uk\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.newsbeep.com\/uk\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.newsbeep.com\/uk\/wp-json\/wp\/v2\/users\/2"}],"replies":[{"embeddable":true,"href":"https:\/\/www.newsbeep.com\/uk\/wp-json\/wp\/v2\/comments?post=34888"}],"version-history":[{"count":0,"href":"https:\/\/www.newsbeep.com\/uk\/wp-json\/wp\/v2\/posts\/34888\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.newsbeep.com\/uk\/wp-json\/wp\/v2\/media\/34889"}],"wp:attachment":[{"href":"https:\/\/www.newsbeep.com\/uk\/wp-json\/wp\/v2\/media?parent=34888"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.newsbeep.com\/uk\/wp-json\/wp\/v2\/categories?post=34888"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.newsbeep.com\/uk\/wp-json\/wp\/v2\/tags?post=34888"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}