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Is the era of central bank independence coming to an end? With the return of Donald Trump to the White House, the question arises. The new president has made no secret of his desire to bring the Federal Reserve, guardian of the world’s main reserve currency, into line.
Of course, the merits of an independent central bank may be overstated. Central bankers took credit for keeping inflation low in the 1990s and 2000s – the Great Moderation – when in reality price stability was largely the product of a global shock to the commodity market. work. This is a result of the integration of China and other developing countries into the global economy. What followed was a profound change in the balance of power between labor and capital and a shift in the distributive struggle between debtors and creditors in favor of the latter. Central bankers have also not distinguished themselves in managing the recent surge in inflation following the Covid pandemic and Russia’s invasion of Ukraine.
However, the alternative to central bank independence is hardly acceptable. We only need to think of the massive politicization of monetary policy, sometimes in Türkiye or Argentina, to illustrate this point. The ability to conduct monetary policy free from government pressure is obviously valuable. The logic is that elected governments have incentives to reduce short-term unemployment at the expense of long-term impacts on inflation and growth. They also have an incentive, when heavily indebted, to rely on inflation to reduce the real value of their debts.
As voters in the 1970s and 1980s understood, such compromises are disastrous. The result was that monetary policy authorities around the world lost credibility. It took extremely high interest rates, a global recession and a central bank inspired by the Fed’s Paul Volcker to put the world back on a path to low inflation. In monetary policy, credibility is essential.
On this basis, there is good reason to believe that independence in pursuing the Fed’s dual mandate of promoting maximum employment and price stability will be vital under a Trump administration that benefits from Republican majorities in the House and Senate. Trump has pledged to pursue a plethora of inflationary macroeconomic and trade policies, such as sweeping tax cuts, heavy import tariffs, and mass expulsions of immigrants, which will force a serious tightening of the labor market. work. Indeed, the US economy will face significant supply shocks coinciding with expansionary fiscal policy. This inexorably points to higher and more volatile inflation, all against a backdrop of public debt exceeding 100 percent of GDP and expectations of a more deregulatory environment in the banking sector that will encourage a return to excessive risk-taking .
Added to this is the eccentric addition of Trump’s crypto obsession. Maurice Obstfeld, former chief economist of the IMF, underlines This crypto poses an unprecedented threat to inflation because most cryptocurrencies, with the exception of stablecoins, are disconnected from the real economy and operate beyond the reach of public policy. They thus introduce significant uncertainty into financial transactions, making them an unreliable basis for economic decisions.
Despite the Fed’s remarkable success in avoiding recession while bringing inflation close to its 2% target, some people on Capitol Hill are promoting crypto as an answer to the central bank’s failure. Obstfeld points out that Republican Senator Mike Lee, for example, characterized the dollar is considered “unstable” because of its alleged role in the federal deficit. He introduced legislation prohibiting the Fed from launching its own digital currency. If passed, Obstfeld says, the ban would leave more room for unregulated cryptocurrencies, potentially facilitating illicit activity. The Fed’s influence on the economy would be reduced.
Additionally, Cynthia Lummis, U.S. Senator from Wyoming, presented a Invoice in July to create a “strategic Bitcoin reserve,” saying it would strengthen the financial position of the United States, providing protection against economic uncertainty and monetary instability. The reality is that the crypto bubble is largely the product of the ultra-accommodative monetary policy that followed the 2007-08 financial crisis. In addition to being ultra-volatile, it has enormous potential to precipitate financial instability, bailouts and recession risk.
Does all this, you might ask, point to a Liz Truss-like fiasco and a field day for bond vigilantes? The short answer is unlikely, because the world’s reserve currency enjoys so-called exorbitant privileges. As long as no other country offers a market as deep and liquid as that of US Treasuries, vigilantism is of little value. That said, the combination of massive government debt issuance and notorious Trumpian unpredictability makes for a toxic mix for markets. The Treasury market is poised for a period of turbulence. Expect financial instability.
john.plender@ft.com
