By Kenneth Rogoff
October 4, 2016
It’s not a completely crazy idea, but I just don’t see it. If Yellen is so determined to keep interest rates in a deep freeze, why has she been trying in recent months to talk up longer-term rates by insisting that the Fed is likely to hike rates faster than the market currently believes?
Central bankers have of course been known to help incumbents before elections, by allowing inflation to drift up and keep employment booming. During US President Richard Nixon’s 1972 re-election campaign, he sternly lectured Fed chair Arthur Burns on the need for pump-priming the economy to help him defeat his Democratic challenger, George McGovern. Nixon won resoundingly, but Burns’ policies helped set off the worldwide inflation of the 1970's and brought forward the breakup of the post-war system of fixed exchange rates. The long-term effects were catastrophic.
Will Yellen launch a rerun of the bad old 1970's, when US inflation hit double digits? I doubt it. Although it is not hard to imagine that Yellen privately holds Trump in the same low regard he holds her, most observers see no signs that inflation is just around the corner.
True, some people still insist that if the Fed doesn’t urgently raise interest rates and rein in the money supply, the US economy will go the way of Zimbabwe (where inflation far exceeded 25,000% in late 2008). But the argument that Fed balance-sheet expansion will translate into high inflation has been colossally wrong for the past six years. Inflation in the US has been consistently below target and, even today, bond yields reflect deep skepticism about whether the Fed has the will or the capacity to sustain price growth at the official 2% target on a consistent basis.
Indeed, those central banks that have tried raising interest rates prematurely, including the European Central Bank and the Swedish National Bank, have been forced to reverse course, and the Fed wants to avoid that fate. The US economy is performing far better these days, and the moment for raising rates further is likely near.
But to infer that an immediate start to further hikes is a no-brainer is ludicrous. In fact, there is still a worldwide downward draft on interest rates, with the ECB and the Bank of Japan still very much in easing mode, as are many smaller central banks. The Fed is already allowing some tightening simply by not playing along, and letting the US dollar appreciate.
To be fair, central banks are not immune to manipulation, and fighting off political pressures is an endless battle. During the financial crisis, the monetary authorities were called on to assume temporary emergency powers, including massive purchases of government and private-sector bonds. For most, including the Fed, there is still no clean exit in sight, and this has made the problem of political insulation more difficult, with or without an election.
Some believe the only salvation is a return to the gold standard era of the late 1800's, when governments fixed the price of their currency in gold, leaving little scope for political interference. Unfortunately, gold bugs seem surprisingly – or perhaps willfully – ignorant of the chronic financial crises and deep recessions of that era. Ultimately, the gold standard collapsed, after governments were forced to abandon it during World War I and thereafter were never able fully to re-establish public trust.
More forward-looking thinkers point to private cryptocurrencies like Bitcoin as the future of money, arguing that they take politics out of the equation entirely. But this, too, is very naive. Governments already can block cryptocurrencies from circulating in the legal economy by restricting bank access, imposing tax laws, and by also impeding retail stores’ ability to accept it. (And, as I explain in my new book The Curse of Cash, Bitcoin can hardly be considered a long-term substitute for large-denomination bills.)
Yes, blockchain technology is very exciting and will likely have many applications in banking, finance, and across the economy. But it is no guarantee against political influence on inflation. In the long history of currency, from coinage to the advent of paper money, the private sector may innovate, but ultimately the public sector appropriates. At the end of the day, the government will always be able to control the rules.
Ironically, the best way to insulate central banks from political pressure would be to expand their toolkit to allow for effective negative-interest-rate policy, though this will take time (as I also discuss in my book). In the meantime, the Fed and other central banks will have to keep walking a tightrope that leaves them especially vulnerable to outside pressure. Fortunately, the Fed has a chair right now who is able and willing to stand up to it.
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